tag:blogger.com,1999:blog-89913698832877120982024-03-07T19:08:49.480-08:00Global Economy MattersUnknownnoreply@blogger.comBlogger544125tag:blogger.com,1999:blog-8991369883287712098.post-74366079550573586582011-05-22T10:04:00.000-07:002011-05-22T10:05:39.074-07:00Russian Demographics - Something Stirring in the East<p style="text-align: left;">By Claus Vistesen: Hull<br /></p><p style="text-align: center;"><br /></p><p style="text-align: center;"><span class="full-image-float-left ssNonEditable"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjX04Qe4VZ4bo4l_eiR-QCYLXF62IQeUuMgY-vGj8SqBqHFcm_FU7SwL0ACUA5yc3M1P3Hef6E-5CVFz393lfQiFAJXIeiX48aeWhWBB6E6MpUmSowqNy1INgLIKUjhuU4_ibYroEmSY0Rj/s320/picture+3.JPG?__SQUARESPACE_CACHEVERSION=1305835562867" mce_src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjX04Qe4VZ4bo4l_eiR-QCYLXF62IQeUuMgY-vGj8SqBqHFcm_FU7SwL0ACUA5yc3M1P3Hef6E-5CVFz393lfQiFAJXIeiX48aeWhWBB6E6MpUmSowqNy1INgLIKUjhuU4_ibYroEmSY0Rj/s320/picture+3.JPG?__SQUARESPACE_CACHEVERSION=1305835562867" alt="" width="257" height="193" /></span><br /></p><p>One of the reasons that I have always had a problem with Goldman Sachs' infamous notion of the BRIC economies was not the fact that it excluded other important economies such as e.g Chile or Indonesia, but rather that Brazil, India, Russia and China never belonged in the same group. The reason for this is largely because of demographics. Both Russia and China are consequently set to age much more rapidly than India and Brazil due to very rapid fertility transition in the 1990s. The demographic situation is especially dire in Russia which not only saw a dramatic and lingering decline in fertility in the 1990s but also saw a corresponding increase in mortality (aids and alcohol as big culprits).</p> <p>A <a href="http://prbblog.org/index.php/2011/04/22/russian-birth-rate-continues-to-rise/" mce_href="http://prbblog.org/index.php/2011/04/22/russian-birth-rate-continues-to-rise/">recent piece by Carl Haub</a> suggests however tha while doom and gloom used to be the prevailing tone on the state of Russian demographics recent trends suggest that this should change.</p> <blockquote> <p>Back in 2000, Russia achieved what Russians consider a dubious milestone, deaths (2,225,300) outnumbered births (1,266,800) by an astounding 958,500. The crude birth rate had sunk to 8.7 births per 1,000 population. Along with a crude death rate of 15.3, natural increase hit an all-time low of –6.6 per 1,000, or –0.7 percent rounded off. The total fertility rate (TFR) bottomed out at 1.195 children per woman. The crisis, as it was seen to be, was definitely noticed, but nothing really effective was done until 2007 when Vladimir Putin announced a baby bonus of the equivalent of $9,000 for second and further births. Putin has been an outspoken advocate for raising the birth rate and improving health conditions in order to avoid the consequences of sustained very low fertility. The program must have worked since births in 2007 jumped to 1,610,100 from 1,479,600 the previous year and have rising ever since. This is one of the very few “success stories” in the industrialized countries’ efforts to raise the birth rate.</p> </blockquote> <p>Together with the rest of Eastern Europe that was re-joined with the West after the fall of the Soviet Union, Russia experienced one of the most brutal fertility transitions ever seen. Indeed, history seems to have been extraordinarily cruel to many countries in Eastern Europe in handing them a second chance at the end of the 1980s just to take it away with the other hand as their demographic fundamentals collapsed. The birth dearth in the East even stretched into <a href="http://clausvistesen.squarespace.com/alphasources-blog/2009/6/20/germanys-shrinking-east.html" mce_href="http://clausvistesen.squarespace.com/alphasources-blog/2009/6/20/germanys-shrinking-east.html">Eastern Germany</a> <a href="http://www.economist.com/node/5637619?story_id=E1_VGPSGTJ" mce_href="http://www.economist.com/node/5637619?story_id=E1_VGPSGTJ">where the</a> <a href="http://www.economist.com/node/5494593?story_id=5494593" mce_href="http://www.economist.com/node/5494593?story_id=5494593">total number</a> of live births fell from 215700 to 88300 in the period 1988 to 1992.</p> <p>I have previously mused that perhaps those multinationals eager to expand eastwards would have to go <a href="http://clausvistesen.squarespace.com/alphasources-blog/2008/4/10/next-stop-kamchatka.html" mce_href="http://clausvistesen.squarespace.com/alphasources-blog/2008/4/10/next-stop-kamchatka.html">all the way to Kamchatka</a> to find qualified labour and perhaps even fail entirely and back in 2006, the only silver lining that the Economist's Berlin correspondent could find was how a residing population had led to a revival of wildlife with the lynx returning to Germany's Eastern borders.</p> <p>Perhaps though, it is time to put this discourse to rest?</p> <p> </p> <p> </p> <p><b><br /></b></p><p><b>Russia in Transition<br /></b></p> <p style="text-align: center;"><span class="full-image-float-left ssNonEditable"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgNbXwEEuQruUAm45K7bNHtnlzPawuvvQFlni-nE-7a-hfwonqHBG_FJPfHbc3ORGCOyop4J3sm2h3Jo27Qlorf4Q5-xPcPcb-dttx-dWhksVfO2yUE8c8HhX3ZxcakzBQaP-HB3pyhhTyI/s320/picture1.JPG?__SQUARESPACE_CACHEVERSION=1305835799788" mce_src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgNbXwEEuQruUAm45K7bNHtnlzPawuvvQFlni-nE-7a-hfwonqHBG_FJPfHbc3ORGCOyop4J3sm2h3Jo27Qlorf4Q5-xPcPcb-dttx-dWhksVfO2yUE8c8HhX3ZxcakzBQaP-HB3pyhhTyI/s320/picture1.JPG?__SQUARESPACE_CACHEVERSION=1305835799788" alt="" /></span><br /></p><p><br /></p><p>From 1989 to 1999/2001 the total fertility rate in Russia fell from replacement levels to around 1.1/1.3 and notable effort [1] has been put into explaining why birth rates fell so much, so quickly.</p> <p>Grogan (2006) uses a household survey tracking data from 1994 to 2001 and finds that a large part of the decline in fertility among married couples can be attributed to the decline in household income in the same period. Grogan (2006) however also sheds light on other aspects of Russia's fertility during the Soviet era. In particular, the paper sets out to explain completed cohort fertility for women born between 1936 and 1961 and finds that women with higher education had considerably lower completed cohort fertility rates than their counterparts. This squares well with the notion of the quantity/quality tradeoff of fertility famously developed by Gary S Becker [2] and how parents substitute quantity for quality as their income levels rise (with education), but it comes with an important twist in the Russian case. Since female labour force participation was almost universal during the Soviet era and since women with less than higher education often earned the same (or more) than their better educated peers, Grogan (2006) seems to imply an inherent demand, by part of well educated women, for quality rather than quantity in their fertility decisions. </p> <p>The other driver of fertility decline in the form of the tempo effect is also present in Russia, but Grogan (2006) is skeptical as to its merits in explaining the sharp fall in fertility in the 1990s. It does appear to coincide with a change in attitude towards marriage and, specifically, births outside marriage, but from 1988 to 2000, mariage rates declined for the broad category of women (aged 15-44) as well as the share of total live births taking place outside marriage rose from about 14% to 26%.</p> <p>In essence, the tempo effect over the period in question is not linear and seems to neutralize itself over time.</p> <p>From 1989 to 1994, the share of births to mothers under 20 actually rose and then declined to just above 1989 levels in 2000. Not surprisingly, the share of total non marital live births among mothers aged less than 20 years rose sharply from 1989 to 2000. This suggests that the extent to which non-marital live births increased, it resulted in children being borne to young mothers. From a theoretical perspective, this is important in relation to how a change in the life course towards postponing marriage also leads to a postponement of childrearing. A norm of non-marriage child births may then serve to weigh against the tempo effect of fertility.</p> <p>This non-linearity of the tempo effect throughout what was essentially a sharp linear decline in fertility is interesting. The charts produced in Grogan (2006, p. 65 fig XI) clearly suggests that from 1989 to 1994 total live births for young mothers aged under 20 as well as those from 20-24 rose as share of overall birhts. This reverses somewhat in 1994 where live births for mothers aged 25-29 starts to increase as well as those aged 30-34. Yet Grogan (2006) notes that since there is no meaningful change in the fraction of total live births of "older" mothers in 2000 relative to 1989, the decline in fertility in Russia is not a postponement phenomenon.</p> <p>Brainerd (2006) builds on the points above by similarly latching on to the idea that the economic hardship bestowed on Russian citizens in the 1990s contributed to the decline in fertility. This suggests again a more permanent negative quantum effect at work rather than merely a postponement phenomenon. But the underlying causes of the fertility decline is cut very finely by Brainerd (2006). Notably, the paper argues for a pure negative income effect on birth rates and thus a reversal of the standard quantity-quality tradeoff as developed by Becker. The interesting thing here is that little evidence is found that general macroeconomic uncertainty (of the future) affect fertility even if women with more negative expectations of the future had a higher propensity of abortion.</p> <p>Quantitatively, Brainerd (2006) finds strong evidence for how marriage and a higher income per capita positively affects fertility using a fixed effect estimation with age specific fertility rates as dependent variable. Since marriage rates and income declined in the period 1989 to 1999, it leads to the conclusion that this caused the decline in fertility. I find this plausible, but would note that the estimation results suggests that underlying uncertainty of the future might still be affecting these results. For example, Brainerd (2006) shows how the effect of income on fertility is strongest for young mothers which indicates that permanent income may be a more useful proxy for linking fertility to income levels than the traditional method of using fluctuations in current income. It also sugggests that the income effect might be lower over time in the aggregate if we assume a general process of postponement, but this is dubious in Russia's case following Grogan (2006).</p> <p><span class="full-image-block ssNonEditable"> </span></p> <p style="text-align: center;" mce_style="text-align: center;"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSbeUm2BDsOvOuhcLkyri1AzgPqYRkj0-0ZOBslCjs3sZsL25jR0EkCfT6Mrv_59W_N3KF4MsQPPGH2B5R8G0KJVR8xcB8zBvrcjk_fKccRxd44CRtWk8_jdPvT3gElQbIooTx0ijS0sEp/s320/picture+5.JPG?__SQUARESPACE_CACHEVERSION=1305838060652" mce_src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSbeUm2BDsOvOuhcLkyri1AzgPqYRkj0-0ZOBslCjs3sZsL25jR0EkCfT6Mrv_59W_N3KF4MsQPPGH2B5R8G0KJVR8xcB8zBvrcjk_fKccRxd44CRtWk8_jdPvT3gElQbIooTx0ijS0sEp/s320/picture+5.JPG?__SQUARESPACE_CACHEVERSION=1305838060652" alt="" /></p> <p style="text-align: center;" mce_style="text-align: center;"><i><span mce_ style="font-size:80%;">And now lets go make some kids ... ?</span></i></p> <p> </p> <p>In general, the tendency of non-marital births is interesting to dwell on and Perelli-Harris (2008) [3] draws a sharp distinction between two reasons to explain it. The first relates to the notion of the second demographic transition [4] which postulates that the extent to which non-marital births occur in stabile cohabitations, as e.g. in the Scandinavian countries, it reflects a change in value towards marriage and thus a change in the life course. Contrary to this stands evidence, largely from the US, that non-marital births are associated with much less stable unions and, generally, poorer levels of society.</p> <p>Not surprisingly, Perelli-Harris et al (2008) do not ascribe either of these explanations to the rise of non-marital fertility in Russia, but rather; a mixture of both. One important aspect here is the extent to which, after a non-marital contraception, women with higher education tend to enter into marriage with a much higher probability than women with lower education. But everyone will be able to find sources to support their argument with for example <a href="http://www.rand.org/pubs/conf_proceedings/CF124/CF124.chap2.html" mce_href="http://www.rand.org/pubs/conf_proceedings/CF124/CF124.chap2.html">this article by Sergei V. Zakharov and Elena I. Ivanova</a> arguing for a more traditional second demographic transition process in Russia.</p> <p>One overarching conclusion which emerges on the fertility decline in Russia is that it was not driven primarily by birth postponement but seems to have been pushed by a more lingering quantum effect. The more specific driving forces of this quantum effect is much more difficult to get a hold on, but from the perspective of the macroeconomist it appears as if Russia entered a sinister spiral of increasing mortality and declining fertility just as the economy was meant to rebuild and then later take off on the much hailed wave of convergence. In particular, it appears as if the general adverse economic environment in Russia in the 1990s may have caused fertility rates to "undershoot".</p> <p> </p> <p><b><br /></b></p><p><b>Pro-natalism in Russia, Action and Reaction?<br /></b></p> <p>While we may certainly look upon Russia's demographic experience as a frightening example of the effect of negative population momentum, it would be unfair to say that the Russian leadership has been sitting idle. In 2006, Vladimir Putin announced a number of pro-natalist initiatives targeted at reversing the the decline of Russia's population. The plan included longer maternity leave, increased child benefits and most notably a full USD 9000 payment to women opting to have a second child Brainerd (2006).</p> <p>In May 2009, president Medvedev <a href="http://www.telegraph.co.uk/news/worldnews/europe/russia/4279145/Russia-awards-order-of-parental-glory-to-prolific-parents.html" mce_href="http://www.telegraph.co.uk/news/worldnews/europe/russia/4279145/Russia-awards-order-of-parental-glory-to-prolific-parents.html">arranged for eigth families to be courted at the Kremlin</a> where they were awarded the Order of Parental Glory; the Levyokin family chosen to represent the Moscow region had, at the time, given birth to no less than 6 children.</p> <p><span class="full-image-block ssNonEditable"> </span></p> <p style="text-align: center;" mce_style="text-align: center;"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh0dkQw2xBGBwzzy6Gd6bAOR6snUONldYbFuDja2hvRK_NHsThmlLa-i-oAab-L9AaTEpEaiUzWVoDpYuEfl70wIRBas9BZMB-lCiDIZXlSoelu7CKSMEZ8b39l2jL5G-XF6DyUoe0BEOpI/s320/picture2.JPG?__SQUARESPACE_CACHEVERSION=1305835719487" mce_src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh0dkQw2xBGBwzzy6Gd6bAOR6snUONldYbFuDja2hvRK_NHsThmlLa-i-oAab-L9AaTEpEaiUzWVoDpYuEfl70wIRBas9BZMB-lCiDIZXlSoelu7CKSMEZ8b39l2jL5G-XF6DyUoe0BEOpI/s320/picture2.JPG?__SQUARESPACE_CACHEVERSION=1305835719487" alt="" /></p> <p style="text-align: center;" mce_style="text-align: center;"><i><span mce_ style="font-size:80%;">Getting his Priorities Straight</span></i></p> <p>The question is whether it has worked?</p> <p>According to Carl Haub it has (see above), and if this is indeed one of the few success stories of how ageing economies can reverse their birth rate, it is worth paying <a href="http://statsaholic.blogspot.com/2010/05/russian-fertility.html" mce_href="http://statsaholic.blogspot.com/2010/05/russian-fertility.html">more than scant attention to</a>. The data here is subject to some uncertainty, but following Haub's lead the total fertility rate in Russia stood at 1.54 in 2010 which is up from a low point of 1.2 in 2000. In addition, Haub notes an important distinction between rural and urban fertility rates with the former standing at 1.9 in 2010 and the latter at 1.42. This last point is difficult to underestimate since it shines a rather pessimistic initial light on the strides to increase fertility in Russia. In particular, it casts russia in a more classic emerging market context witha a very abrupt quantity/quality trade-off at work whereby especially urban fertililty undershoots significantly below the replacement level. </p> <p>Still, the aggregate picture is improving.</p> <p><i>(click on charts for better viewing)</i></p> <p style="text-align: center;" mce_style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhGbZtQqUT9g5VctgU-1K1FYvQrZRl2okJFDcP_bKMAc1azyzbhWVFrH-EwmcOH1S-JK6QCU7SJNXellBGJnY4CiPU07yJb_R45UgZN4aZQvswprTmYhtl8cVwe_97wD7jYr09iUV6kgxgV/s1600/russia+-+breaking+the+fertility+trap.JPG" mce_href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhGbZtQqUT9g5VctgU-1K1FYvQrZRl2okJFDcP_bKMAc1azyzbhWVFrH-EwmcOH1S-JK6QCU7SJNXellBGJnY4CiPU07yJb_R45UgZN4aZQvswprTmYhtl8cVwe_97wD7jYr09iUV6kgxgV/s1600/russia+-+breaking+the+fertility+trap.JPG"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhGbZtQqUT9g5VctgU-1K1FYvQrZRl2okJFDcP_bKMAc1azyzbhWVFrH-EwmcOH1S-JK6QCU7SJNXellBGJnY4CiPU07yJb_R45UgZN4aZQvswprTmYhtl8cVwe_97wD7jYr09iUV6kgxgV/s320/russia+-+breaking+the+fertility+trap.JPG?__SQUARESPACE_CACHEVERSION=1305835995436" mce_src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhGbZtQqUT9g5VctgU-1K1FYvQrZRl2okJFDcP_bKMAc1azyzbhWVFrH-EwmcOH1S-JK6QCU7SJNXellBGJnY4CiPU07yJb_R45UgZN4aZQvswprTmYhtl8cVwe_97wD7jYr09iUV6kgxgV/s320/russia+-+breaking+the+fertility+trap.JPG?__SQUARESPACE_CACHEVERSION=1305835995436" alt="" /></a></p> <p> </p> <p>In the jargon of the profession we must now be seriously asking whether Russia is about to join the very few nations that has managed to break free of the fertility trap defined here as how total fertility rates often don't recover (or has not recovered yet!) once they fall below 1.5. The only two other countries which have seen their fertility levels rebound from below 1.5 are Denmark and France.</p> <p>I would happily announce that this is the case, but the plot is just about to thicken.</p> <p>On the positive side and given evidence from the academic literature that the tempo effect is not a relevant phenomenon in a Russian context, it stands to reason that this rebound can be interpreted as a real change in sentiment towards having children.</p> <p>Score one for Russia's pro-natalist policies then?</p> <p>To some extent though Carl Haub pours water on this idea noting that the second derivative of the fertility increase is falling which leads him to ponder whether the rise of Russian births is losing steam. This argument is taken further by Kumo (2010) [5] who suggests that not only did Russia's pro-natal policies not work in the first place, but also that the rise in the number of births can be attributed entirely to fluctuations in the number of women in their reproductive age. More importantly however, Kumo (2010) emphasizes the difficulties of micro managing fertility and specifically the issue of just how difficult it is to get a lasting impact on fertility from cash transfers. In short, empirical evidence shows that pro-natalist policies rarely have a permanent effect. This is even more likely to be significant in a Russian context as the fund set up to dole out money to fertile mothers expires in 2016.</p> <p> </p> <p><b><br /></b></p><p><b>Ageing in Russia, Adjusting for Mortality<br /></b></p> <p>To assume that the Russian government's attempt to push up fertility rates will have a lasting permanent effect is probably as dubious as assuming that it will have no effect at all. In addition, if Russia is serious about securing a future balanced population pyramid, what is to say that there won't be more initiatives?</p> <p>Still, it appears that just as Russia seem to be making strides in the fertility department, the appalling situation for adult male mortality continues to taint the overall picture. Here, the optimists will call foul play and point out how the main story on Russian demographics has recently been a <i>co-movement</i> of improving mortality and fertility rates. This may be true, but overall conditions are still poor.</p> <p>According to data from the World Bank only a mere 47.4% of a male cohort can expect to celebrate their 65th birthday which contrasts with 78.5% for women. On average (from 1998 to 2009) only 44.5% of a given male cohort could expect to reach 65 years.</p> <p><span class="full-image-block ssNonEditable"> </span></p> <p style="text-align: center;" mce_style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgseOxmXN2SETqN_z8m8AFpBX1OAYC7hx-kJEi6CtfVbCgxPdg2V_U_MOHE9eb-zfkbxg36_aF-TgTKe5bZ_uU4TmXCQvp2TbmfOtMjA7xQurnqmYGY-SkfeCTHqGQzRIOWQylMSdzOPRXn/s1600/russia+-+time+to+man+up.JPG" mce_href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgseOxmXN2SETqN_z8m8AFpBX1OAYC7hx-kJEi6CtfVbCgxPdg2V_U_MOHE9eb-zfkbxg36_aF-TgTKe5bZ_uU4TmXCQvp2TbmfOtMjA7xQurnqmYGY-SkfeCTHqGQzRIOWQylMSdzOPRXn/s1600/russia+-+time+to+man+up.JPG"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgseOxmXN2SETqN_z8m8AFpBX1OAYC7hx-kJEi6CtfVbCgxPdg2V_U_MOHE9eb-zfkbxg36_aF-TgTKe5bZ_uU4TmXCQvp2TbmfOtMjA7xQurnqmYGY-SkfeCTHqGQzRIOWQylMSdzOPRXn/s320/russia+-+time+to+man+up.JPG?__SQUARESPACE_CACHEVERSION=1305835829875" mce_src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgseOxmXN2SETqN_z8m8AFpBX1OAYC7hx-kJEi6CtfVbCgxPdg2V_U_MOHE9eb-zfkbxg36_aF-TgTKe5bZ_uU4TmXCQvp2TbmfOtMjA7xQurnqmYGY-SkfeCTHqGQzRIOWQylMSdzOPRXn/s320/russia+-+time+to+man+up.JPG?__SQUARESPACE_CACHEVERSION=1305835829875" alt="" /></a></p> <p style="text-align: center;" mce_style="text-align: center;"> </p> <p style="text-align: center;" mce_style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDPkbasiHWJ4eQ1XpM6bB4_AmaoTctS46Itv4Jjzh3U3_VZu8BAKhFvL50EQZTr_-t0N02lBJhuVvLe16OlOlNnW_tRGL8Aa52_9lKG036FoClqG5MzPnmc7tunxAA5UTuhUxLj2B5vZyM/s1600/russia+-+still+too+many+deaths.JPG" mce_href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDPkbasiHWJ4eQ1XpM6bB4_AmaoTctS46Itv4Jjzh3U3_VZu8BAKhFvL50EQZTr_-t0N02lBJhuVvLe16OlOlNnW_tRGL8Aa52_9lKG036FoClqG5MzPnmc7tunxAA5UTuhUxLj2B5vZyM/s1600/russia+-+still+too+many+deaths.JPG"><span class="full-image-block ssNonEditable"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDPkbasiHWJ4eQ1XpM6bB4_AmaoTctS46Itv4Jjzh3U3_VZu8BAKhFvL50EQZTr_-t0N02lBJhuVvLe16OlOlNnW_tRGL8Aa52_9lKG036FoClqG5MzPnmc7tunxAA5UTuhUxLj2B5vZyM/s320/russia+-+still+too+many+deaths.JPG?__SQUARESPACE_CACHEVERSION=1305836428879" mce_src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDPkbasiHWJ4eQ1XpM6bB4_AmaoTctS46Itv4Jjzh3U3_VZu8BAKhFvL50EQZTr_-t0N02lBJhuVvLe16OlOlNnW_tRGL8Aa52_9lKG036FoClqG5MzPnmc7tunxAA5UTuhUxLj2B5vZyM/s320/russia+-+still+too+many+deaths.JPG?__SQUARESPACE_CACHEVERSION=1305836428879" alt="" /></span></a> </p> <p> </p> <p>Despite the visible improvement since the mid 2000s, the evidence from a birds eye view has not changed. Male life expectancy seems to be mean reverting around 61 to 62 (at birth) and mortality for adult males exhibits an increasing trend. An afinity to Vodka and other spirits as well as <a href="http://www.lshtm.ac.uk/centres/ecohost/public_health/premature/" mce_href="http://www.lshtm.ac.uk/centres/ecohost/public_health/premature/">too many cigarettes</a> <a href="http://ideas.repec.org/p/cfr/cefirw/w0128.html" mce_href="http://ideas.repec.org/p/cfr/cefirw/w0128.html">appear to be lingering killers</a>. <a href="http://www.thelancet.com/journals/lancet/article/PIIS0140-6736%2809%2961034-5/abstract" mce_href="http://www.thelancet.com/journals/lancet/article/PIIS0140-6736%2809%2961034-5/abstract">Recent research</a> (2009) from the medicinal sciences using mortality patterns from Tomsk, Barnaul and Biysk suggests alcohol was a cause of more than half of all Russian deaths at ages 15-54 years.</p> <p>As a result, the natural increase is still negative as the up-tick in births has still not managed to pip the mortality rate here even if it seems a more lasting change may be underway here.</p> <p><span class="full-image-block ssNonEditable"> </span></p> <p style="text-align: center;" mce_style="text-align: center;"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgqKFWlnsfvzPMy7Xr_q930CiAoYSkROtL1E_4WGEfR_sUbeHUwsTt9FTdZoolAzJsSgewDVpvWvW5WHA_wVdIILoT52-0RLIcuriJJ3T_dgFcDvTuNx4l-SCXYM92TbgScM0NWTfWGbJeo/s320/picture+4.JPG?__SQUARESPACE_CACHEVERSION=1305836522394" mce_src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgqKFWlnsfvzPMy7Xr_q930CiAoYSkROtL1E_4WGEfR_sUbeHUwsTt9FTdZoolAzJsSgewDVpvWvW5WHA_wVdIILoT52-0RLIcuriJJ3T_dgFcDvTuNx4l-SCXYM92TbgScM0NWTfWGbJeo/s320/picture+4.JPG?__SQUARESPACE_CACHEVERSION=1305836522394" alt="" /></p> <p style="text-align: center;" mce_style="text-align: center;"><i><span mce_ style="font-size:80%;">A Rare Sight</span></i></p> <p>Regardless of the permanency of recent years' improvement in fertility Russia cannot escape a rapid process of ageing. More than anything, this is why I so ardently argue against lumping Russia together with India and Brazil or more specifically; in Russia there is no positive demographic dividend in sight; rather what we have is a negative one.</p> <p> </p> <p style="text-align: center;" mce_style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhVG2P652ncdAH_4rYvoeal6Dy74-SudHWvOVJRyqszYc8iUz_Qurm3mA8-XtznWwSQt6OdAcLJK3BwLbniW9F_vtGXQWUCdkIJPcrPpiz6cOE2Ai1izTQP0hEl2szWVEt5dyarGkjLz_4q/s1600/Russia+pop+and+dep+ratio2.JPG" mce_href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhVG2P652ncdAH_4rYvoeal6Dy74-SudHWvOVJRyqszYc8iUz_Qurm3mA8-XtznWwSQt6OdAcLJK3BwLbniW9F_vtGXQWUCdkIJPcrPpiz6cOE2Ai1izTQP0hEl2szWVEt5dyarGkjLz_4q/s1600/Russia+pop+and+dep+ratio2.JPG"><span class="full-image-block ssNonEditable"><span><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhVG2P652ncdAH_4rYvoeal6Dy74-SudHWvOVJRyqszYc8iUz_Qurm3mA8-XtznWwSQt6OdAcLJK3BwLbniW9F_vtGXQWUCdkIJPcrPpiz6cOE2Ai1izTQP0hEl2szWVEt5dyarGkjLz_4q/s320/Russia+pop+and+dep+ratio2.JPG?__SQUARESPACE_CACHEVERSION=1306083751479" mce_src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhVG2P652ncdAH_4rYvoeal6Dy74-SudHWvOVJRyqszYc8iUz_Qurm3mA8-XtznWwSQt6OdAcLJK3BwLbniW9F_vtGXQWUCdkIJPcrPpiz6cOE2Ai1izTQP0hEl2szWVEt5dyarGkjLz_4q/s320/Russia+pop+and+dep+ratio2.JPG?__SQUARESPACE_CACHEVERSION=1306083751479" alt="" /></span></span></a></p> <p> Of course, we cannot simply assume that the Russian population will fall from here on as one would assume (and hope) that Russia manages to reverse the trend in mortality. What we can see however is that in terms of the prime age group (35-54), Russia is likely to have peaked already in 2004 even if the effect of the double hump is interesting to consider (a result of assuming a perpetually declining population).</p> <p><span class="full-image-block ssNonEditable"> </span></p> <p style="text-align: center;" mce_style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjR8126zFQgYuRxOVLv-UGIuBNMieYf_o9A8t4jjs7kFhjIDj0uR4pWrXzqvPPg18AJiNSwQHsTc6Dfr1eeNKlZdx6NeuCvM6VoLLvzBgJeFoJoe_DrqlLuR_d7wrthenFVLufRtBvUsvpW/s1600/russia+3554.JPG" mce_href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjR8126zFQgYuRxOVLv-UGIuBNMieYf_o9A8t4jjs7kFhjIDj0uR4pWrXzqvPPg18AJiNSwQHsTc6Dfr1eeNKlZdx6NeuCvM6VoLLvzBgJeFoJoe_DrqlLuR_d7wrthenFVLufRtBvUsvpW/s1600/russia+3554.JPG"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjR8126zFQgYuRxOVLv-UGIuBNMieYf_o9A8t4jjs7kFhjIDj0uR4pWrXzqvPPg18AJiNSwQHsTc6Dfr1eeNKlZdx6NeuCvM6VoLLvzBgJeFoJoe_DrqlLuR_d7wrthenFVLufRtBvUsvpW/s320/russia+3554.JPG?__SQUARESPACE_CACHEVERSION=1305836624904" mce_src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjR8126zFQgYuRxOVLv-UGIuBNMieYf_o9A8t4jjs7kFhjIDj0uR4pWrXzqvPPg18AJiNSwQHsTc6Dfr1eeNKlZdx6NeuCvM6VoLLvzBgJeFoJoe_DrqlLuR_d7wrthenFVLufRtBvUsvpW/s320/russia+3554.JPG?__SQUARESPACE_CACHEVERSION=1305836624904" alt="" /></a></p> <p>In addition, the process of ageing means that there is almost no chance of Russia being able to contribute to global rebalancing by sustainably running an external deficit. This is one of the single most important macroeconomic characteristics which suggests why we should not label Russia as an "emerging" economy. Russia and the CEE will instead be fighting to escape the mantle that they may just have grown old befor they made it to become rich.</p> <p><span class="full-image-block ssNonEditable"> </span></p> <p style="text-align: center;" mce_style="text-align: center;"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlL4Fh7DT_Bft91Xv9IRm67KCzxZ7cfkP7hWsPaQu9podF8HBBgqiQtdLNG1EFZmkUlsAM6_v0VnyFvr79Cl4CyoKqg5zraV9JjH8qz0KVy2rkhL5yCNcRvPAA3_jyqgh5IKlDvvbTUiUx/s320/russia+pop+shares.JPG?__SQUARESPACE_CACHEVERSION=1305836655223" mce_src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlL4Fh7DT_Bft91Xv9IRm67KCzxZ7cfkP7hWsPaQu9podF8HBBgqiQtdLNG1EFZmkUlsAM6_v0VnyFvr79Cl4CyoKqg5zraV9JjH8qz0KVy2rkhL5yCNcRvPAA3_jyqgh5IKlDvvbTUiUx/s320/russia+pop+shares.JPG?__SQUARESPACE_CACHEVERSION=1305836655223" alt="" /></p> <p>Especially the younger part of the labour force will invariably be subject to a swift decline and the composition of the labour force is crucial to consumption smoothing on the aggregate level and thus capital flows.</p> <p>However, the most important aspect in the context of ageing in Russia is to adjust for the continuing high mortality rate among men. In <a href="http://www.sciencemag.org/content/329/5997/1287.summary" mce_href="http://www.sciencemag.org/content/329/5997/1287.summary">a recent piece in Sciencemag</a> Warren C. Sanderson and Sergei Scherbov argue that we should rethink ageing given that as the world population ages so does the threshold at which we can consider a person (or population) to be "old".</p> <blockquote> <p>(...) as life expectancies increase and people remain healthy longer, measures based solely on fixed chronological ages can be misleading. Recently, we published aging forecasts for all countries based on new measures that account for changes in longevity (<i>5</i>–<i>8</i>). Here, we add new forecasts based on disability status. Both types of forecasts exhibit a slower pace of aging compared with the conventional ones.</p> </blockquote> <p>This makes perfectly good sense and governments around the world are busy pushing up retirement ages to reflect this, but does this apply in a Russian context? What good would it do to push up the retirement age in Russia if less than half of a male cohort makes it to 65? The principle applied by messieurs Scherbov and Sanderson cuts both ways and in Russia's case we must incorporate an additional accelerant in our analysis of ageing to account for the continuing high rate of mortality and indeed an effect which will take some decades to pass through the pyramid.</p> <p> </p> <p><b><br /></b></p><p><b>Something Stirring in the East? </b></p> <p>The recent improvement in Russia's demographic indicators begs the question of whether the glass is half full or half empty. On the former I would note two things. Firstly, Russia has indeed seen a noticeable improvement in both fertility and mortality and it seems to have coincided with the government's strategic aim to actually do something about the country's decaying demographics. Secondly, I will salute the effort in itself. We can all probably agree that Russia has veered a little too much towards the way of authoritarianism under Putin, but whatever the underlying ambitions to push forward a positive population agenda I think it is extraordinarily important.</p> <p>On the latter however, I am still worried that the trend in mortality have not been reversed and that, if anything, the situation is improving all too slowly. I am open to a more positive spin, but the data and an, admittedly scant, look at the evidence gives little comfort. As a result, ageing in Russia will be much more acute and its effect will have a much larger and negative impact than if life expectancy was a steadily increasing function of time. Indeed, given the continuing poor state of especially male health in Russia it is questionable whether the measures above of "peak growth" apply at all.</p> <p>The most important feature of Russia's demographic rebound is its potential permanency and especially we should watch whether Russia manages to stay above a fertility rate of 1.5. If this turns out to be case, we could harbour a hope that not only lynxes but also a rejuvenated Russian population may be stirring in the East.</p> <p> </p> <p>---</p> <p>* All photos in this essay are taken from <a href="http://www.flickr.com/photos/barthelomaus/3924972751/" mce_href="http://www.flickr.com/photos/barthelomaus/3924972751/">Creative</a> <a href="http://www.flickr.com/photos/centralasian/5256916603/" mce_href="http://www.flickr.com/photos/centralasian/5256916603/">Commons</a> <a href="http://www.flickr.com/photos/ainokami/2277535227/" mce_href="http://www.flickr.com/photos/ainokami/2277535227/">License</a> <a href="http://www.flickr.com/photos/adam_jones/3773481827/" mce_href="http://www.flickr.com/photos/adam_jones/3773481827/">accounts</a> <a href="http://www.flickr.com/photos/numbozz/5555445616/" mce_href="http://www.flickr.com/photos/numbozz/5555445616/">at Flickr</a>. Data for the charts are from the World Bank Database and US Census Bureau (long term population forecasts).</p> <p> </p> <p>[1] - In the following I will make extensive use of Louise Grogan (2006) - <a href="http://www.economics.uoguelph.ca/lgrogan/russfertility_pce_final.pdf" mce_href="http://www.economics.uoguelph.ca/lgrogan/russfertility_pce_final.pdf"><i>An Economic Examination of the Post-Transition Fertility Decline in Russia</i></a> and Elizabeth Brainerd (2006) - <a href="http://web.williams.edu/Economics/brainerd/papers/fertility_rf.pdf" mce_href="http://web.williams.edu/Economics/brainerd/papers/fertility_rf.pdf"><i>Fertility in Transition: Understanding the Fertility Decline in Russia of the 1990s</i></a>.</p> <p>[2] - Becker, G. (1960) - <i>An economic analysis of fertility</i>, In Demographic and Economic Change in Developed Countries. NBER: New York</p> <p>[3] - <span class="citation"><span class="creators"><span class="person_name">Perelli-Harris, </span></span></span>Brienna and Gerber, Theodore P. (2008) <a href="http://paa2008.princeton.edu/download.aspx?submissionId=81366" mce_href="http://paa2008.princeton.edu/download.aspx?submissionId=81366"><i>Non-marital fertility in Russia: second demographic transition or low human capital?</i></a> In, Population Association of America 2008 Annual Meeting, New Orleans, US 17 - 19 Apr 2008. , 33pp.</p> <p>[4] - The second demographic transition has many sources but <a href="http://www.ipss.go.jp/webj-ad/webJournal.files/population/2003_4/Kaa.pdf" mce_href="http://www.ipss.go.jp/webj-ad/webJournal.files/population/2003_4/Kaa.pdf">these ones by Dirk J. van de Kaa</a> are a good <a href="http://www.demogr.mpg.de/Papers/workshops/010623_paper04.pdf" mce_href="http://www.demogr.mpg.de/Papers/workshops/010623_paper04.pdf">starting place</a>.</p> <p>[5] - Kazuhiro Kumo (2010) - <a href="http://www.voxeu.org/index.php?q=node/5132" mce_href="http://www.voxeu.org/index.php?q=node/5132"><i>Explaining fertility trends in Russia</i></a>, VOX EU</p>CVhttp://www.blogger.com/profile/16843402165210120665noreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-89993497934870379872011-05-15T14:34:00.000-07:002011-05-16T01:05:47.723-07:00Greece: Last Exit To Nowhere?by Edward Hugh: Barcelona<br /><br /><blockquote>"Some economists, myself included, look at Europe’s woes and have the feeling that we’ve seen this movie before, a decade ago on another continent — specifically, in Argentina" - Paul Krugman: <a href="http://www.nytimes.com/2011/01/16/magazine/16Europe-t.html?pagewanted=1">Can Europe Be Saved</a><br /><br />"Think of it this way: the Greek government cannot announce a policy of leaving the euro — and I’m sure it has no intention of doing that. But at this point it’s all too easy to imagine a default on debt, triggering a crisis of confidence, which forces the government to impose a banking holiday — and at that point the logic of hanging on to the common currency come hell or high water becomes a lot less compelling."<br />Paul Krugman - <a href="http://krugman.blogs.nytimes.com/2010/04/28/how-reversible-is-the-euro/">How Reversible Is The Euro?</a></blockquote><br />Krugman is certainly right. Looking over towards Athens right now, you can't help having that horrible feeling of deja vu. Adding to the uncomfortable feeling of travelling backwards rather than forwards in time (oh, I know, I know, when history repeats itself it only piles one tragedy onto another) is the uncomfortable presence of Charles Calomiris, a US economist of Greek origins. I can still remember reading, back then in the autumn of 2001, an article by the then Argentine Economy Minister Domingo Cavallo published in the Spanish newspaper El Pais which proudly proclaimed that everything was going well, and that the country's reforms were being generally well received with the regretable exception of "a small number of neurotic US economists who continue to insist that we will default and break the peg". He was, of course, referring to Calomiris, and at the time we were only a matter of weeks away from the dramatic moment when Adolfo Rodríguez Saá (the man who was President for a mere 8 days) would enter both history and the Argentine parliamentary chamber to utter the now immortal phrase "vamos a coger el torro por los cuernos" (we are going to take the bull by the horns). A phrase which was obviously belonged to the class of so called <a href="http://en.wikipedia.org/wiki/Performative_utterance">Austinian performatives</a>, since at one and the same time as uttering it he effectively ended the peg. Well today Calomiris is again with us, and he is still hard at work going through the numbers, only this time round he is using his special insights to scrutinise his family homeland, for which he is prophesying not only eventual default, but also the generation of sufficient contagion <a href="http://www.foreignpolicy.com/articles/2011/01/06/the_euro_is_dead">to bring the whole Euro project itself to an untimely end</a>. In an article in Foreign Affairs entitled "The End Of The Euro", he tells us:<br /><br /><blockquote>Europe is living in denial. Even after the economic crisis exposed the eurozone's troubled future, its leaders are struggling to sustain the status quo. At this point, several European countries will likely be forced to abandon the euro within the next year or two....The only way out of this conundrum is for countries with insurmountable debt burdens to default on their euro-denominated debts and exit the eurozone so that they can finance their continuing fiscal deficits by printing their own currency. Here's a hint for Europe's politicians: If the math says one thing and the law says something different, it will be the law that ends up changing</blockquote>Really, I don't think of Calomiris as a prophet (or even as a Cassandra), I don't even think of him as an especially insightful economist when it comes to the macro problems of the real economy, but I do think he has one exceptionally strong merit: he can do the math, and as he says, if it gets down to a battle between legal details and arithmetic, arithmetic will always win.<br /><br /><b>Easy Said & Easy Done, Down the Argentina Path We Go!</b><br /><br />As it happens, the issue of Argentina as a reference case for Greece has surfaced again this week, in the form of <a href="http://www.nytimes.com/2011/05/10/opinion/10weisbrot.html?_r=1&hp">an Op-ed in the New York Times by the co-director of the Center for Economic and Policy Research Mark Weisbrot</a>.<br /><br />Weisbrots's argument is not new, but it is different, not only because he thinks Greece would be better off leaving the euro (many economists share that opinion), but because of the apparent eulogy he makes of the Argentine case.<br /><br /><blockquote>"For more than three and a half years Argentina had suffered through one of the deepest recessions of the 20th century......Then Argentina defaulted on its foreign debt and cut loose from the dollar. Most economists and the business press predicted that years of disaster would ensue. But the economy shrank for just one more quarter after the devaluation and default; it then grew 63 percent over the next six years. More than 11 million people, in a nation of 39 million, were pulled out of poverty"</blockquote>.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZuqSGYFRDfZ8c4Gimcfi_Jsw2igO55F0W-BWLOTbaSLIWYRSDJ4TEoaookHMhBniHHTByxVrZMZa-FItgz9FHswqzsWYEsBc_rNVwFBAuG9bXfdcirTuGsAprG4KMCzk65PdziLBWYY5_/s1600/Chile+and+Argentina.png"><img style="margin:0px auto 10px;text-align:center;cursor:pointer;cursor:hand;width: 400px;height: 213px" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZuqSGYFRDfZ8c4Gimcfi_Jsw2igO55F0W-BWLOTbaSLIWYRSDJ4TEoaookHMhBniHHTByxVrZMZa-FItgz9FHswqzsWYEsBc_rNVwFBAuG9bXfdcirTuGsAprG4KMCzk65PdziLBWYY5_/s400/Chile+and+Argentina.png" border="0" alt="" /></a><br /><br />Now these are strong claims. But let's leave aside the issue of whether or 11 million people were pulled out of poverty or not, and dig a bit deeper into what actually happened in Argentina, and let's do this by comparing it with another country, one which arguably has similar social and economic development characteristics, Chile (see chart above). At the turn of the century Chile had a population of more or less 15 million, as compared with the 39 million Argentinians mentioned by Weisbrot. Now in 1998, just before Argentina entered its depression, Chilean GDP was some 79 billion dollars, while Argentina's was 299 billion dollars. Now let's fast forward to 2010, Argentina's GDP at the end of last year was 370 billion dollars, and Chile's 203 billion. That is to say, between 1998 and 2010 Argentina's GDP (as measured in dollars, we'll come back to this) increased by 24%, while Chile's increased by 156%. As they say in Spanish "no hay color" (there is simply no comparison). Especially when you take into account when that Chile has only 38% of Argentina's population, while it has 55% of Argentina's GDP. So over the 12 years between 1998 and 2010 Chile (which maintained a floating currency throughout) evidently did a lot better than Argentina (despite Argentina's abandonment of the float). And here's another relevant piece of information: between 1998 and 2010 the Argentinian price level rose by 143%, while in Chile the price level rose over the same period by 48%.<br /><br />So why use USD as the measure of comparison? I do this since it gives the most convenient yardstick evaluation (euros would do equally well) of the relative external values of the two economies. This is important, since Argentina apparently high growth levels have been also associated with high inflation levels, which have been constantly compensated for by devaluing the peso. In fact Bank of America Merrill Lynch currency strategist - and former IMF economist - Thanos Vamvakidis makes an essentially similar point (although with different conclusions) <a href="http://ftalphaville.ft.com/blog/2011/05/12/567256/devaluation-the-great-greek-damp-squib/">in a research note covered recently by FT Alphaville's Tracy Alloway</a>:<br /><br /><blockquote>"In our view, ...(the results of our study).... point to the conclusion that exchange rate devaluations do not lead to permanent competitiveness improvements in rigid economies, such as in the Eurozone periphery. In this context, tail risk scenarios about EUR exit are misplaced. Structural reforms are the best bet to improve the periphery’s growth prospects, within or outside monetary union".</blockquote><br />Does this whole debate sound familiar to anyone? Anyone remember when Italians were paying themselves in million lira notes? In fact, it was precisely to break the Southern European countries from the high inflation, high interest rates, periodic devaluation dynamic that the Euro was thought to be such a good idea in the first place. It hasn't worked as planned, but that doesn't mean that the most traditional and the most simplistic solutions are necessarily going to be the best ones.<br /><br />On the other hand, does this mean we should then go on to dismiss the coming out of the euro option out of hand for Greece? Evidently not. Let's look at another comparison, this time Argentina and Turkey.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZRMzKKYJcd6unqO17-9Q52NOHZa0W0Z5umm0qBd5gz-JFtXHB9GZQQzUw4Q_exfSGL3r11Qzi_hclUGYNIZryosP1CZ5e4-F_hu3w2x9KJtnM35lMzDYurfcjtHciCaqPQCAaY5XZg-Di/s1600/Argentina+and+Turkey.png"><img style="margin:0px auto 10px;text-align:center;cursor:pointer;cursor:hand;width: 400px;height: 215px" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZRMzKKYJcd6unqO17-9Q52NOHZa0W0Z5umm0qBd5gz-JFtXHB9GZQQzUw4Q_exfSGL3r11Qzi_hclUGYNIZryosP1CZ5e4-F_hu3w2x9KJtnM35lMzDYurfcjtHciCaqPQCAaY5XZg-Di/s400/Argentina+and+Turkey.png" border="0" alt="" /></a><br /><br />Now in 1998 Turkey had a dollar GDP of $269 billion, and by 2010 this had become $742 billion. That is it had nearly tripled. Yet Turkey's dollar GDP dropped sharply in 2001 following a substantial devaluation of the Lira. Conclusion, competitive devaluations are sometimes useful, so what makes the difference?<br /><br />Well Paul Krugman got near to it, <a href="http://krugman.blogs.nytimes.com/2011/05/10/greek-out/">when he said in his article on Weisenbrot's proposal</a>:<br /><br /><blockquote>"Greece, as a relatively poor country with a history of shaky governance, has a lot to gain from being a citizen in good standing of the European project — concrete things like aid from cohesion funds, hard-to-quantity but probably important things like the stabilizing effect, economically and politically, of being part of a grand democratic alliance".</blockquote><br /><br />We can sum the essence of all this up in a couple of phrases "institutional quality" and "structural reforms". Or put another way, Turkey devalued as part of an IMF programme (it was actually recommended, in the days before the heavy hand of the EU took management control at the IMF), while Argentina broke the peg and devalued in order to get out of one. Turkey was not only able to benefit from the reform pressure instigated by the IMF (the stick), but also by the promise of EU membership under certain conditions (the carrot). Indeed, curiously, EU cultural reservations about Turkish membership have probably lead to far stricter reform hurdles than were either applied to the current members in the South or the East, and Turkey is undoubtedly the great beneficiary of this strictness.<br /><br />Which brings us to the main point: should Greece leave or not leave the Euro? Well, let's go back to something Krugman said in another blog post (<a href="http://krugman.blogs.nytimes.com/2010/04/28/how-reversible-is-the-euro/">How Reversible Is The Euro</a>):<br /><br /><blockquote>"Think of it this way: the Greek government cannot announce a policy of leaving the euro — and I’m sure it has no intention of doing that. But at this point it’s all too easy to imagine a default on debt, triggering a crisis of confidence, which forces the government to impose a banking holiday — and at that point the logic of hanging on to the common currency come hell or high water becomes a lot less compelling."</blockquote><br /><br />or <a href="http://krugman.blogs.nytimes.com/2011/05/10/greek-out/">as he argues in his latest post</a>:<br /><br /><blockquote>"That said, Weisbrot is right in saying that the program for Greece is not working; it’s not even close to working. At the very least there must be a debt restructuring that actually reduces the debt burden rather than simply stretching it out. And the longer this situation remains unresolved, the less hope I have that Greece will be able to stay in the euro, even if it wants to".</blockquote><br /><br />The present situation is unworkable, and unsustainable, not only because the accumulated debts are unpayable by Greece alone, but also because the tiny size of the manufacturing industry Greece has ended up with and the general lack of international competitiveness of the Greek economy make an export-lead growth process with the present state of relative prices virtually impossible. There are solutions to both these problems consistent with remaining within the Eurone and without default - issuing Eurobonds to accept part of the Greek debt and enforcing a substantial internal devaluation to restore external competitiveness, for example - but since the adoption of these two strategies is virtually unthinkable given the current mindsets in Brussels, Frankfurt, Berlin and Madrid then we are more or less guaranteed to find ourselves facing some kind of Greek default, and given that the programme as it stands isn't working (this is where the situation so resembles pre-default Argentina as the extent of the fiscal correction means the economic contraction feeds on itself given that exports cannot expand fast enough to counteract the decline in government spending and domestic consumption), it would be strongly advisable to accompany this default with some sort of devaluation.<br /><br />Put another way, if the most valid argument against going back to the Drachma always was that this would imply default, now that default is coming, why not allow Greece to devalue? As Krugman says, the issue isn't whether Greece would openly decide to exit the euro, the issue is what happens if the markets force this solution on Greek and European leaders against their will? Given the programme isn't working, the likelihood of this kind of event occurring in the next 2 or 3 years is far from being negligible, so why not be proactive rather than always relegating ourselves to being reactive? What matters is whether Greece becomes Turkey (oh, what a historical irony) or Argentina. If the powers that be can agree on an ordered restructuring of Greek debt, and a controlled exit from the Eurozone, then Greece has some possibilities of turning the situation round. If exit is forced on Greece in order to escape the clutches of both the EU and the IMF then the move will be, as I suggest in my title, simply the last exit to nowhere. And especially in a historic context of ageing populations and rapidly rising elderly dependency ratios, ratios which will only rise further if thousands of young people exit Greece in the search for work elsewhere, as young Argentinians did in 2002/3. That's another difference most people who make this comparison don't mention: when Argentina devalued the country still had a fertility rate which was slightly above replacement level. Greece has just had more than 30 years with a total fertility rate in the region of 1.3. So while Argentina could look forward to years of demographic dividend and rapid "catch up" growth, if things go wrong Greece can only look forward to an ever older population and ongoing social and economic decline<br /><br />The tragi-comic events surrounding the fate of IMF Director General Dominique Strauss Kahn may well mean that we are about to see significant changes in that organisation. It is to be hoped that, if this is the case, such changes will also involve a rethink of the IMF's role in Europe's crisis, and in particular of the objectives and means of implementation of the Greek programme, with the Fund moving towards a less-eurocentric and more balanced position, one which would be in the collective interest of the community of citizens of the wide variety of countries the institution represents.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-65997884815881468502011-05-15T04:01:00.000-07:002011-05-15T04:03:30.539-07:00The Great Greek And Spanish GDP Mystery - One Hypothesisby Edward Hugh: Barcelona<br /><br />Many an economic eyebrow must have been raised last Friday when Europe's first quarter GDP data was released, and people discovered that the Greek economy had suddenly surged forward, rising by 0.8% over the level it had attained in the last three months of 2010 (or at a 3.2% annual rate, or faster than the US). Since almost everyone with knowledge of the situation is forecasting a further contraction in the economy this year, the result may have been thought to be a surprising one.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj4V4vVULXyRUBpt0AbGJGNCKjxhHVTCtEquHCmRwGsptZYFYB_NbSzLU5VJ6ZTCaLRL5BoZOYMLMSWjhbtbO1WUsG7OWpMCRGKb2OFYaV1bin-TW12XYRlyS-I6ZeL0NrcxMwtEXgVorJo/s1600/Greece+GDP+Q-o-Q.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj4V4vVULXyRUBpt0AbGJGNCKjxhHVTCtEquHCmRwGsptZYFYB_NbSzLU5VJ6ZTCaLRL5BoZOYMLMSWjhbtbO1WUsG7OWpMCRGKb2OFYaV1bin-TW12XYRlyS-I6ZeL0NrcxMwtEXgVorJo/s400/Greece+GDP+Q-o-Q.png" border="0" alt="" /></a><br /><br />Well, there is no need to call in Sherlock homes just yet, or even the strong-arm boys from Eurostat, since I think I may have worked out what happened to Greek GDP in Q1, or at least I have a good working hypothesis. In the process we will also examine why it was that, against all prognoses, and against a colossal amount of anecdotal evidence that the Spanish economy is falling back towards recession, Spanish GDP actually accelerated.<br /><br />But first, a brief intro to Econ 101 macro. It is important to grasp the fact that GDP isn't the be all and end all of economic analysis, and certainly doesn't give us a complete measure of economic activity. Indeed there are many economic processes which may be of interest to economists - levels of indebtedness, for example, which are simply not captured by the measure, since GDP is what it is: a measure of domestic value added, according to the following formula:<br /><br />GDP = Consumer Demand + Investment Demand + Government Spending + Net Trade (change in exports minus change in imports) + Net Change in Inventories<br /><br />Now, in general we know that the first three items on the list are falling in Greece. even if there does seem to have been some slight improvement in retail sales during the quarter, after a very steep fall in the autumn.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEipnPLzK2POxQdYNCKSPHsLGZYoCY8WmStIQzZ71nBiQZGSQfmcqj85Nr-Mb7QGpChpXWGwWTYLq7f8PozIoHiIDTJ2TGP4AMcEFuT5SGHwcLmF5GMvSLPKj7WezVhZft1KtYe4_LsCFWrg/s1600/Greece+retail+sales.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 218px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEipnPLzK2POxQdYNCKSPHsLGZYoCY8WmStIQzZ71nBiQZGSQfmcqj85Nr-Mb7QGpChpXWGwWTYLq7f8PozIoHiIDTJ2TGP4AMcEFuT5SGHwcLmF5GMvSLPKj7WezVhZft1KtYe4_LsCFWrg/s400/Greece+retail+sales.png" border="0" alt="" /></a><br /><br />But what about the net trade component? Well, before going further it is important to consider is how this calculation works. Basically net trade can improve <strong>either</strong> by the rate of export growth accelerating, <strong>or</strong> by the rate of import growth decelerating. Now in Greece we know that exports have improved, but Greek exports are proportionally so small, and form such a limited part of total economic activity, how can they possibly pull the economy upwards in this way (causing a 0.8% q-o-q increase in GDP)? Well, looking at the chart for imports it can be seen that just as exports have been accelerating, imports have been decelerating, so the combined impact might be quite large (please note we don't yet have the March data).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgeUpLTcbcIkcU0zZRl_O03ctWT81rhyphenhyphenkaotiw2AOOWj9v2m6aVLRCN79kptTdiXyI8mEoZBqZJpY34T7oBTOrYSXU9wF66mifjslMMl_kp1PGZcEXd0YzFI_8WrWPHNh47DX7BhKSrtA_P/s1600/Greece+Imports.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgeUpLTcbcIkcU0zZRl_O03ctWT81rhyphenhyphenkaotiw2AOOWj9v2m6aVLRCN79kptTdiXyI8mEoZBqZJpY34T7oBTOrYSXU9wF66mifjslMMl_kp1PGZcEXd0YzFI_8WrWPHNh47DX7BhKSrtA_P/s400/Greece+Imports.png" border="0" alt="" /></a><br /><br />This impression that it was as much a drop in imports as a rise in exports that was behind the sharp quarterly rise in GDP is further reinforced if we look at the year on year performance of the two variables. In recent months Greek imports are sharply <strong>down</strong> y-o-y (despite the surge in energy prices) while exports are <strong>up</strong>.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiYl-g6fPNuIeSRMwelXCp9fs6OunMNnOyM3bhk-4M025WWIMXcKfbWR2rqk8d-o7aIQHt-D2bed1JCCPpajrLZMmK8KD5Oqa4sOCljsrss3zT33Ogl7IzOto82HIN5araNtRHc83R88VPN/s1600/Greece+Imports+year+on+year.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 224px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiYl-g6fPNuIeSRMwelXCp9fs6OunMNnOyM3bhk-4M025WWIMXcKfbWR2rqk8d-o7aIQHt-D2bed1JCCPpajrLZMmK8KD5Oqa4sOCljsrss3zT33Ogl7IzOto82HIN5araNtRHc83R88VPN/s400/Greece+Imports+year+on+year.png" border="0" alt="" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjAxJWFCbNIPfsCSgrmRMQF19AyVuWqz8wr06fZakkdkXDFgsQwKvp-YcXiY2km-ANeE8sJEaqf5rY-kpYNrtyq86C5K1EVJCD9nfseosbAA_WqlKllnBFni1CV9pF_iaAJKWViMpUxqEPh/s1600/Greece+Exports+year+on+year.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjAxJWFCbNIPfsCSgrmRMQF19AyVuWqz8wr06fZakkdkXDFgsQwKvp-YcXiY2km-ANeE8sJEaqf5rY-kpYNrtyq86C5K1EVJCD9nfseosbAA_WqlKllnBFni1CV9pF_iaAJKWViMpUxqEPh/s400/Greece+Exports+year+on+year.png" border="0" alt="" /></a><br /><br />So GDP rose, but what about does this tell us about living standards? Well, this is just the point. Since the fall in imports reflects a fall in demand, it implies a fall in living standards,and this is the strange thing about what GDP measures and what it doesn't measure. GDP can rise sharply, even when unemployment is rising, and people are getting poorer. This is largely because one of the things GDP doesn't measure is the evolution of what some call the "financial balances" (for more explanation of this idea see the pioneering work of the Canadian economist Rob Parenteau (<a href="http://www.nakedcapitalism.com/2010/03/parenteau-on-fiscal-correctness-and-animal-sacrifices-leading-the-piigs-to-slaughter-part-1.html">here in somewhat polemical form</a>, and <a href="http://neweconomicperspectives.blogspot.com/2009/07/employing-krugmans-cross-farewell-mr.html">here as a more technical explanation</a>).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_5EEQ4I8ysnzxfFpCYW30rCLsBLq1xDmWMkAQmc7YJP4aEtM8AMOeTgh1ObNn0vy1D81c4FcvCZkvICw0w1V3jKA41Bgq5WQQq8cMbWQxhY79iWu5kyJiOa6yttWc2j3mNnnqO4jfkeb2/s1600/Greece+current+account+monthly.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_5EEQ4I8ysnzxfFpCYW30rCLsBLq1xDmWMkAQmc7YJP4aEtM8AMOeTgh1ObNn0vy1D81c4FcvCZkvICw0w1V3jKA41Bgq5WQQq8cMbWQxhY79iWu5kyJiOa6yttWc2j3mNnnqO4jfkeb2/s400/Greece+current+account+monthly.png" border="0" alt="" /></a><br /><br />In countries running an ongoing trade and current account deficit, the rise in living standards which comes from an increasing excess of imports over exports figures in national accounts as an <strong>output negative</strong> (apart from the transport and retail outlet activity which are a spin-off), and the counter party to all that "living beyond our means" feel-good added credit-driven purchasing power really only shows up as a negative item on the financial side of the accounts, as money borrowed from the exterior, money which is used to finance the deficit. It is a negative item, because all that potential capacity to spend is being diverted away from national activity to external activity. So while you pay for the products consumed (through debt) others get the long term benefit of your spending. Which is why it is such a bad idea to run sizeable current account deficits over any great length of time, since they are financed by credit, and credit is only a way of transferring demand from the future to the present, which means you will feel richer now, and poorer in the future, and this is exactly what is happening to Greece. It is also why the only way to put the situation straight is to export more, and run a trade and current account surplus, since then the value of your net external debt falls. So the correction is necessary and inevitable, although the curious thin is that while it is taking place, and while exports are rising and imports and living standards falling GDP rises, even though people feel much worse off.<br /><br />Obviously, having an economy appearing to accelerate like this is a bit counter intuitive. Evidently it is not the same as having a devaluation-induced import-reduction with demand remaining equal, and more productive activity taking place inside the country as relative prices result in steady import substitution, but then demand deflation policies have these peculiarities attached. Maybe we could think of the type of correction Greece is engaged in as less future demand being brought forward to today, under the hope that the subsequent path of the economy will eventually be on a higher level than it otherwise would have been. Pay now, live later.<br /><br />In the Greek case, since private sector borrowing is at a total standstill, and public sector deficit borrowing is being steadily reduced, the current account deficit is being forced to close, with the consequence that since exports can't rise much (due to competitiveness issues, and their low base) imports will need to fall while unemployment will probably continue to rise.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi1zX0rY8_28Q5m5Q2Qn5TzvQK1G92BRkB48KoBxjJKX4XiPDEREm7pEIRPDISJMooSKDsaERpVov1oh8rkQhVaYBmEw0dERmsB6lmqJ29wdt2wdNIm9sRb2Grf0Bl9H9bCx4oBT7AMXYyM/s1600/Greece+Bank+Lending+To+Households.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi1zX0rY8_28Q5m5Q2Qn5TzvQK1G92BRkB48KoBxjJKX4XiPDEREm7pEIRPDISJMooSKDsaERpVov1oh8rkQhVaYBmEw0dERmsB6lmqJ29wdt2wdNIm9sRb2Grf0Bl9H9bCx4oBT7AMXYyM/s400/Greece+Bank+Lending+To+Households.png" border="0" alt="" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhHct9a-GB_RqhQvVARd-xNYz-l2lf3GAaks4T6lTVn-9AnuHhDntEmm6Q5V2dc-M5bDnjksswT4PDZQX8C0N7uwPVXORlRBrxfjUbrYF-xgrC6LPL9Gx9FPNLHkQ6_E2yLMF3AbkAYuwXM/s1600/Greece+Bank+Lending+to+Corporates.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhHct9a-GB_RqhQvVARd-xNYz-l2lf3GAaks4T6lTVn-9AnuHhDntEmm6Q5V2dc-M5bDnjksswT4PDZQX8C0N7uwPVXORlRBrxfjUbrYF-xgrC6LPL9Gx9FPNLHkQ6_E2yLMF3AbkAYuwXM/s400/Greece+Bank+Lending+to+Corporates.png" border="0" alt="" /></a><br /><br />If this analysis of what has been going on in Greece is correct, then it can also help us understand the latest set of Spanish GDP numbers a bit better. According to the latest data, in the first quarter of this year Spain's GDP rose by 0.3% over Q4 2010 and by 0.8% over the year earlier quarter. This surprised many analysts since the Bank of Spain has previously estimated growth to be around 0.2%, and a number of 0.1% was often anticipated.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgQHPAtTWdAAokvJ9oyCJZuk2-IlvqqJf6N7Kn25pMGj9FQjlctOYW9E0Zw-NywSyPgY7cxJ-1pKCZ9rdTpjpojjdxeyEyWfX2eqP3N2neouLYyg-w-K4uu2Z7i_lm18BrUfD1jehCX40Rw/s1600/gdp++two.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgQHPAtTWdAAokvJ9oyCJZuk2-IlvqqJf6N7Kn25pMGj9FQjlctOYW9E0Zw-NywSyPgY7cxJ-1pKCZ9rdTpjpojjdxeyEyWfX2eqP3N2neouLYyg-w-K4uu2Z7i_lm18BrUfD1jehCX40Rw/s400/gdp++two.png" border="0" alt="" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjGTAR6oJPyCYXZ-uv8ktz0U4UQUr-u5pmGFDujyYHu2iXuWg3DayYtX3A_mbFQjt_U5NiYfY3etawUAi6GXON4uYJcxkVG3zJyfWml_ek8w6o1qIWa70zLP_CCrT5OAGslMcFkIlVavuHe/s1600/gdp+one.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjGTAR6oJPyCYXZ-uv8ktz0U4UQUr-u5pmGFDujyYHu2iXuWg3DayYtX3A_mbFQjt_U5NiYfY3etawUAi6GXON4uYJcxkVG3zJyfWml_ek8w6o1qIWa70zLP_CCrT5OAGslMcFkIlVavuHe/s400/gdp+one.png" border="0" alt="" /></a><br /><br />In theory the Q1 performance marks an acceleration over the 0.2% quarterly rise registered in the last quarter of 2010. Such an acceleration seems odd, since all the recent data, industrial output, retail sales, unemployment has been negative, and doubly so since the government is in the process of a very sharp (3.2%) fiscal adjustment process.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOiQKo9-A2W7WTpLpwh8YllMguTEcf0l5jORrDOqW5rc9Lr3wR402B7g6aYB_zo68Z4E2D_K_atME6SqsU3ivu1DRFOWjEVTe8y-j80O9GLtsNlyfmNOskUlzbu0PPvI4sm5NuNCuUui5Z/s1600/industrial+output.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 210px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOiQKo9-A2W7WTpLpwh8YllMguTEcf0l5jORrDOqW5rc9Lr3wR402B7g6aYB_zo68Z4E2D_K_atME6SqsU3ivu1DRFOWjEVTe8y-j80O9GLtsNlyfmNOskUlzbu0PPvI4sm5NuNCuUui5Z/s400/industrial+output.png" border="0" alt="" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvj-x1YvhN2KXWNt6zjtGOWZrSrFhVSSSwsfPuGX6MFBo4rb2uvOXlPZV3XglMCnQJjpEJR7JW_n3vD2HY1Z7xv3FSCYfNzQOkf64b9HhQpw4BEVmJtLcdIJdVw3pMeusOvYG0U-mSAA6l/s1600/retail+sales.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvj-x1YvhN2KXWNt6zjtGOWZrSrFhVSSSwsfPuGX6MFBo4rb2uvOXlPZV3XglMCnQJjpEJR7JW_n3vD2HY1Z7xv3FSCYfNzQOkf64b9HhQpw4BEVmJtLcdIJdVw3pMeusOvYG0U-mSAA6l/s400/retail+sales.png" border="0" alt="" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg2jDro51NRqrs6Vpci5_pPHsafljdEgjfd8J8dnBEl6k-UKhYLqDd3MkXvyzagylDF2ye3aZlJu6YO3eAFJFk8cmPFbg_nU3UsUwlEitMzMe7oMpFsb7dS5qHBKk49lzdiJv6r1nmquAqU/s1600/unemployment+one.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg2jDro51NRqrs6Vpci5_pPHsafljdEgjfd8J8dnBEl6k-UKhYLqDd3MkXvyzagylDF2ye3aZlJu6YO3eAFJFk8cmPFbg_nU3UsUwlEitMzMe7oMpFsb7dS5qHBKk49lzdiJv6r1nmquAqU/s400/unemployment+one.png" border="0" alt="" /></a><br /><br />Yet, if we come to look at the relative import/export performance, we will see a milder version of the same phenomenon. It seems exports rose and imports fell in the first quarter, creating a very special kind of "win-win" situation.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj3JpFCSWoqQ3UQqbFqxvnIHjczUkIA_ev2fifOVnRG2nut26zuMSvV42ld_SNQwrXTXATutnNWorhZLf9J9muDtnPTCCvs3NuqsTUBams5cS1pfHUawK8Okn7fEAr104ar2QY1ez6YRg7O/s1600/WTO+Imports.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 218px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj3JpFCSWoqQ3UQqbFqxvnIHjczUkIA_ev2fifOVnRG2nut26zuMSvV42ld_SNQwrXTXATutnNWorhZLf9J9muDtnPTCCvs3NuqsTUBams5cS1pfHUawK8Okn7fEAr104ar2QY1ez6YRg7O/s400/WTO+Imports.png" border="0" alt="" /></a><br /><br />This is a much milder version of the Greek story, but possibly similar processes are at work in both cases, as Spain's previously large current account deficit is also being steadily forced to close.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgUDLcCa9MRw1bHPJGaFEb3HX-e-q28Y2Sk3RgfwpPHIJoVd3BRupne_WBSVx6akZ0oxtBV8MA69uZxxHNhDSrjjzNOqP9xc1TIFC04H-NaRcl0EAz39ms8JsR3YnCCMajvbG4FCMStA25t/s1600/current+account+balance.png"><img style="margin: 0px auto 10px; text-align: center; cursor: hand; width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgUDLcCa9MRw1bHPJGaFEb3HX-e-q28Y2Sk3RgfwpPHIJoVd3BRupne_WBSVx6akZ0oxtBV8MA69uZxxHNhDSrjjzNOqP9xc1TIFC04H-NaRcl0EAz39ms8JsR3YnCCMajvbG4FCMStA25t/s400/current+account+balance.png" border="0" alt="" /></a><br /><br />On the other hand, in Spain's case other factors might be at work, like <a href="http://www.economist.com/node/18621761">overspending before this month's regional and local elections</a>. In any event, I am describing all the above as a hypothesis because we still don't have either the March trade data or the detailed GDP data. When we have access to both of these we will have a better idea of just how valid this hypothesis of mine actually is. At the end of the day, one swallow doesn't make a summer, and one month's GDP surprise is simply a drop in the ocean in relation to the major challenges which face these economies in the quarters and years ahead.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-77843598051718355642011-05-09T07:44:00.000-07:002011-05-09T08:40:12.313-07:00Is There Really Such A Thing As A Eurozone Credit Cycle?by Edward Hugh: Barcelona<br /><br /><blockquote>America, we know, has a currency union that works, and we know why it works: because it coincides with a nation — a nation with a big central government, a common language and a shared culture. Europe has none of these things, which from the beginning made the prospects of a single currency dubious.<br />Paul Krugman - <a href="http://www.nytimes.com/2011/01/16/magazine/16Europe-t.html?pagewanted=1">Can Europe Be Saved?</a></blockquote><blockquote>All theory depends on assumptions which are not quite true. That is what makes it theory. The art of successful theorizing is to make the inevitable simplifying assumptions in such a way that the final results are not very sensitive.' A "crucial" assumption is one on which the conclusions do depend sensitively, and it is important that crucial assumptions be reasonably realistic. When the results of a theory seem to flow specifically from a special crucial assumption, then if the assumption is dubious, the results are suspect.<br />Robert Solow, A Contribution To the Theory of Economic Growth, 1956</blockquote><br /><br />One of the key premises underpinning the establishment of the Euro as a common currency to be shared by a number of individual national states rather than one single nation was the central idea that the several economies of the participating countries would eventually converge to one common typology. That is to say, even if the individual nations would not be dissolved into one single superstate, then the idea was that the difficulty this could obviously create would be overcome by the generation of a number of different, but to all-important-economic-effects identical economies, each one a replica (in minature or "a lo grande") of the other. Absent this, it is hard to see how people could have convinced themselves that having a single currency and a single monetary policy could possibly work in the longer term.<br /><br /><b>Convergence Towards a Common "Steady State"?</b><br /><br />This critical idea of convergence was based on a simple (and possibly rather simplistic) application of the kind of neo-classical economics widely taught in the modern university. Every economy, it is postulated, is capable of generating some sort of relatively constant "steady state" growth rate , and given the application of sound common monetary policy and an appropriate mix of relevant structural reforms these relatively constant growth rates should not diverge too much one from the other, since if they did, and continued to do so on a sustained basis, then a fiscal mechanism would need to be created to serve as a stabiliser able to redress the consequences of such steadily diverging rates of growth with the associated large differences in living standards. Political consensus could never realistically be maintained behind a process which was manifestly generating inequality between participating countries.<br /><br />Naturally, if there was no eventual convergence then any fiscal mechanism which was created would need to be something more than an ad hoc fund for handling the impact of a one-off asymmetric shock (like the bursting of a property bubble), since it would need to be permanent and systematic and operate in a way which is broadly similar to the internal redistribution mechanisms which operate between north and south in countries like Spain and Italy, or between rich and poor states in the USA. The fact is, during the course of the current crisis, no one with any degree of institutional authority even in the most desperate of moments has been prepared to publicly contemplate the possibility that the creation of such a territorial equalisation mechanism might eventually be need, even though, as will be argued here, successfully saving the Eurozone will almost inevitably mean putting just such a fiscal compensator in place. Just think about it: the Greeks never had a fiscal deficit problem at all, since what was lacking was adequate compensation for their growth imbalances! You can just see the anxious (or enraged) look on all those German faces. Yet just this is the conclusion that I think can be drawn about the creation of a common currency area among a group of countries where convergence is not operative, since the consequence of not doing so, as is now becoming clear enough, is that the countries with lower underlying growth profiles become steadily weighed down by the burden of their indebtedness to the higher growth economies - that is to say debt obligations are created where fiscal transfers are lacking.<br /><br />Now, as we all have come to know only too well, this kind of fiscal mechanism was neither contemplated by the founding fathers of the Euro, nor has anything even remotely resembling it been envisioned as part of the collective response to the present crisis. Indeed the need for its creation remains one of the most highly controversial topics in the current debate (rivalling in the emotional charge it engenders only the suggestion that some sort of internal devaluation might be needed for the zone's struggling peripheral economies). Advocacy of this move has been restricted to commentators outside the mainstream, most notably among them Wolfgang Munchau (see <a href="http://www.ft.com/cms/s/0/ceca784c-f02a-11df-88db-00144feab49a.html#axzz1LkVkIcpw">here</a>, and <a href="http://www.ft.com/cms/s/0/f1432a66-6917-11e0-9040-00144feab49a.html#axzz1LkVkIcpw">here</a>), and for his pains he has acquired the honorary title of "Enemy of Spain" from the Spanish newspaper El Mundo, who presumably found his suggestion that Spain might need to be a beneficiary of such a mechanism an insult to their national honour.<br /><br /><b>Diverging Not Converging Economies?</b><br /><br />Meanwhile back in the world of the real economy, nothing could be more evident from all the signs we are seeing during the present recovery than that the Euro Area economies are not converging - indeed they are visibly diverging in all manner of different ways. Some economies are now called "peripheral", and others are called "core". Yet neither the core, nor the peripheral economies resemble the other members of their sets in a way which standard theory might lead you to expect that they should.<br /><br />France is a domestic consumption driven economy, running a goods trade deficit, where manufacturing industry seems to be losing competitiveness, while Germany has weak domestic consumption, is completely export driven, runs a large external surplus, and German manufacturing industry seems to get more (rather than less) competitive by the day.<br /><br />Among the peripheral economies Greece would seem to distinguish itself for its extreme fiscal profligacy, while Italy and Portugal have just passed through a decade of slow growth, which contrasts with the case of Spain and Ireland where fiscal deficits and government debt were not a large issue during the first decade of the Euro's existence, but where a growing mountain of private sector debt (fuelled by negative interest rates and a growing housing bubble evidently was) evidently was.<br /><br />The consequences of needing to accommodate policy to this diversity of economic "types" have, however, still to be recognised, yet the lessons of why convergence hasn't occurred do need to be assimilated, otherwise effectively staying in denial will only raise the chances of an eventual disorderly disintegration of the zone itself. Interestingly, Poul Thomsen, IMF Mission Chief for Portugal <a href="http://www.imf.org/external/pubs/ft/survey/so/2011/INT050611A.htm">recently emphasised in the context of the bailout there</a> that as far as the IMF is concerned, "Every country is different and there is no one-size-fits-all for the programs we support". How long will it be before this message reaches Frankfurt?<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEjVwa-6zojkCZBIR8Tma1KsSbbaRH2lLKiwLlv0LQGG2dAzoEspSaFRCm5R-tgCxk537c-Y-JV970dPyP3UvTART1Ckv1LH8IwJ0sp70-9ACl93uUafawvnHemrvLVaKsQALHoxoZwHeK/s1600/Core+versus+Periphery.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 240px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEjVwa-6zojkCZBIR8Tma1KsSbbaRH2lLKiwLlv0LQGG2dAzoEspSaFRCm5R-tgCxk537c-Y-JV970dPyP3UvTART1Ckv1LH8IwJ0sp70-9ACl93uUafawvnHemrvLVaKsQALHoxoZwHeK/s400/Core+versus+Periphery.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604290144047065778" /></a><br /><br />As an anecdotal aside, I cannot help having the feeling that the practitioners of academic neo-classical economics spend far too much of their time building models based on premises which remain far from self-evident in order to tell the world how it ought to be, leaving the pathways through which empirical facts-on-the-ground could work their way back to influence or modify the initial assumptions rather obscure, to say the least.<br /><br />To give one example, on a recent visit to the monetary policy department of one of Europe's smaller central banks I found myself engaged in a rather frustrating debate about the relative merits of competitive devaluation and structural reform as ways of getting heavily-indebted export-dependent economies back to economic growth and job-creation in sufficient volume to be able to start paying down the debt. Unfortunately the discussion became a rather unrewarding "dialogue of the deaf" of the kind to which I have by now become so accustomed. In fact the whole think so evidently became so tiresome that one of the ever courteous central bank particpants took me aside on my way out to reassure me that "there was of course nothing personal in our exchange". Well, of course not! But that being said, the debate did seem to me to be rather asymmetric and one-sided, because while I am absolutely convinced you need structural reform alongside any (hypothetical) competitive devaluation (otherwise all the old ills simply return), the other side of the argument obviously does not accept the need for competitive devaluations to accompany structural reform. Au contraire, the one is seen as the complete and much more desirable alternative to the other.<br /><br />During our discussions, in my frustration at the fact we were obviously getting absolutely nowhere, I asked the central bank representatives what it would take to convince them they were wrong. Surely, I asked, if the economies in question did not return to a reasonable and sustainable growth rate within the next 3 to 5 years, then they would need to ask themselves whether or not they had been doing something wrong. I for my part clearly recognise that if those economies I consider to be in need of competitive devaluations to underpin structural reforms do achieve significant and sustainable economic growth over the next five years without them then I have been missing something, somewhere (in fact I consider such recognitions of reality to be in my own best interest, to be taken on board on a "sooner the better" basis). Yet,“no”, came the answer, loud and clear, “that would simply mean that the structural reforms had not been deep enough or sufficiently energetically implemented”.<br /><br />I am now put in mind of a recent (and rather infamous) press conference given by the Real Madrid football club coach José Mourinho. When asked by one of the journalists what responsibility he felt his players and he had in the recent series of defeats by their rival Barcelona FC, "zero" was the answer he gave to the astonished journalist. Well, there you go, learning by doing in action!<br /><br />Am I the only one to find something strange (and even frustrating) about this kind of answer? What is the connection between the fundamental assumptions of the kind of economics that is being applied in this crisis on Europe's periphery (which in many ways means prioritizing micro and ignoring the core theorems of applied macro) and reality? And how do we test these assumptions? Surely anyone with any kind of scientific frame of mind should look for facts that can confirm (or better, following in the footsteps of Sir Karl Popper refute) the hypotheses they advance. Which brings us back to the lack of symmetry in the argument we are having at the moment. I personally do consider the lessons learnt from our attempts to handle the crisis to form a vital part of the knowledge acquisition process. As I say, I for my part am clear that if these economies do return to reasonable and sustainable growth within a 3 to 5 year time horizon, then there will be something wrong with the way I have been going about things. On the other hand, since several hundred million Europeans are currently being subjected to a massive social and economic experiment, it would be a pity if economic theory were to prove itself unable to learn anything substantial from the eventual outcomes.<br /><br />In the meantime I find myself gasping for air, trying to pin down threads in the argument that can be examined and tested, which is why I think the convergence issue is important, since either convergence is taking place or it isn't. Put another way, is convergence taking place across a meaningful, in the here and now, time horizon, or is it simply one of those things which is only destined to happen in the longest of long runs by which time, as Keynes so tactfully put it, we will all be well and truly dead? Evidently the future of the Euro depends on the kind of answer you give to this question, and the conclusions you draw from that answer.<br /><br /><b>Business Cycles and "Business Cycles"</b><br /><br />Now one of the areas in which mainstream economic theory surfaces in search of some real world air is in the context of what many analysts call the “credit cycle”. This concept is interesting, since it allows for the introduction of some data, and enables us to take a look and see if the real world is as theory (and all those models they work with) imagines it should be.<br /><br />In fact, the idea of a credit cycle is a natural offshoot of the idea of a business cycle, insofar as central banks pass though an interest rate cycle which maps to some extent movements in the business cycle (that is to say as the economy slows rates come down, and as it accelerates they go up), while demand for credit in the private sector of the economy tracks movements in both of the aforementioned cycles. That is to say, private demand for credit declines during recessions (despite the fact that interest rates fall, and public sector demand for credit rises to offset this drop and cushion real economy impacts), while the subsequent recovery in the demand for private sector credit can be seen as one of the key indicators influencing central bank decision taking when it comes to interest rate policy, since an over-rapid expansion in credit can produce excess demand which can lead to inflation, and in a “normal” world central banks tend to want to fend off any unwarranted surge in inflation or in inflation expectations.<br /><br />The problem with all this is that business cycles are not such straightforward beasts as they are often assumed to be, nor is it really clear how useful conventional business cycle theory really is during a structural (as opposed to cyclical) crisis like the one we are presently living through. Evidently in every economic expansion (or contraction) there is a structural and a cyclical component, and normally the former is less important than the latter in explaining short term movements in output, but during the present crisis this situation has been reversed in both the developed and the developing economies. Take the following charts illustrating recent growth patterns in the Spanish and Chinese economies, can anyone really spot the cyclical components, since I sure as hell can’t.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjeBsEu9X4AvaAX209Jl7wKxFLXa-NrXeynIHfKyTJlSrBwlhxMqBXXALGIGKX2kevoAXcNPvBCScE1lzi_MDyNypNKa9hi40HKdqoVezw92OIXrCV-k4tbs0U_3EOs58wukbv5r9GvoBmn/s1600/Spain+GDP+quarterly+volume+index.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjeBsEu9X4AvaAX209Jl7wKxFLXa-NrXeynIHfKyTJlSrBwlhxMqBXXALGIGKX2kevoAXcNPvBCScE1lzi_MDyNypNKa9hi40HKdqoVezw92OIXrCV-k4tbs0U_3EOs58wukbv5r9GvoBmn/s400/Spain+GDP+quarterly+volume+index.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604328800629387346" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiq9GvcoAXYnY_6keGNgrGc7etwlDhYbmwXElur1L31Np1KpZJ7p1dA5vLs0j-lUmoXg_ojY1xq4a2RJO5tgBKAu4SnS1an8wu6qiVMnaHYlviGcqA2JGC6K481G5Kk6CyBIg1F05grCGce/s1600/China+GDP+annual.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 238px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiq9GvcoAXYnY_6keGNgrGc7etwlDhYbmwXElur1L31Np1KpZJ7p1dA5vLs0j-lUmoXg_ojY1xq4a2RJO5tgBKAu4SnS1an8wu6qiVMnaHYlviGcqA2JGC6K481G5Kk6CyBIg1F05grCGce/s400/China+GDP+annual.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604325044033116850" /></a><br /><br />Spain didn't have a single quarter of contraction following the ending of the 1992/93 recession until the great global economic crisis broke out, and China hasn't had one during this century at least. Obviously in each case there are reasons for these phenomena (catch up growth, inappropriate expansionary monetary policy lifting you through the roof), but the only point I want to make is that they are clear examples of where structural elements far outweighed cyclical ones, and I would argue that this situation is much more common than is often admitted.<br /><br />So, we need to be very careful, and in the context of the current global recovery we need to be be at great pains in trying to distinguish between cyclical and structural components in growth, whether this is in the context of growth in GDP or in private sector credit.<br /><br /><b>A Eurozone Credit Cycle?</b><br /><br />Now one of the points of core dogma which is institutionally enshrined at the heart of the ECB is that aggregate Eurozone data has some sort of useful, or valid, or interesting interpretation. So strongly is this belief held that the central bank representatives seldom examine interpretations of the data that drill down and try to identify what is happening (and more importantly why it is happening) at the individual country level. This is hardly surprising since as suggested above, the very existence and survival of the Euro is seen as hanging on the idea that (given the appropriate country level structural reforms) all the individual economies will converge, and any recognition that tailor-made monetary policies are needed for individual countries would be tantamount to accepting that the founding assumptions of the monetary union had sprung a leak.<br /><br /><br />However, as we will see, credit conditions do in fact vary widely across member countries, and this uneven availability-of and demand-for credit across the Eurozone has become just one more headache to add to the far from small number policy-makers at the ECB currently have, since the growing economic recovery in some countries is being facilitated by the relatively easy availability of credit, while in others problems resulting from a debt overhang and a lack of competitiveness are only reinforced by the difficulties their banking systems face when trying to provide new credit to viable enterprises and solvent households.<br /><br />In any event, starting with the aggregate data released by the ECB such as it is, we find that Eurozone-wide bank lending - which has (truth be told) remained far from strong since the official ending of the recession - lost some of its limited momentum in March, suggesting any real recovery in aggregate Eurozone domestic demand is still a long way off. Private-sector lending increased during the month by 2.5% over March 2010, after rising by 2.6% year on year in February. In fact, the recovery from the economic and financial crisis has been characterised across the Eurozone by weak bank lending, particularly to businesses, and although the annual growth rate of loans to non-financial corporations rose in March, it continued to expand at the relatively modest rate of 0.8% following a 0.6% rise in February. Loans to households have been doing slightly better, and grew at a 3.4% rate compared with the 3.0% registered during the previous month. The annual growth rate of lending for house purchases grew to 4.4% in March from 3.8% in February.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4hcIiByjGyPLcVYZD5YPQw5CmofkfDzalK3tunsY86kqlrYDSi1XTVSp-K85urHshMZjZvQty1ENJzR9AUXdWkmOakYG_6iIvrEUEQDltzblKmI7MoRcUq_etb73wzkkRQcwYKHiZhuLW/s1600/Eurozone+Credit.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 399px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4hcIiByjGyPLcVYZD5YPQw5CmofkfDzalK3tunsY86kqlrYDSi1XTVSp-K85urHshMZjZvQty1ENJzR9AUXdWkmOakYG_6iIvrEUEQDltzblKmI7MoRcUq_etb73wzkkRQcwYKHiZhuLW/s400/Eurozone+Credit.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604708911608935858" /></a><br /><br />(The legend and titles in the above chart are in Catalan, since they have been taken from a report by Catalunya Caixa, but if you bear in mind that "Societats No Financeres" are private sector corporates, "Llars: Consum" is household consumption and "Llars: Habitatge" is home mortgages then you shouldn't have too much difficulty, especially if you remember that the economic net worth of this data asymptotically approaches zero, in the sense that the more time you put into trying to understand it the less you will really learn about how the Eurozone actually works).<br /><br />At the same time broad money, or M3, rose by an annual 2.3% (M3 comprises currency in circulation, overnight, short-term deposits and debt securities of up to two years, repurchase agreements, and money market fund shares), and the three-month moving average of the annual rate of change of M3 was +2.0%. Thus monetary growth still remains well below the ECB's reference value of +4.5% for the three-month average, a monetary growth rate it considers to be broadly in line with an inflation rate of just under 2% over the medium term, implying there is little risk that broad money growth will push up inflation in the eurozone, although it is unlikely that this particular detail will cut much ice with policymakers at the ECB in relation to their interest rate decisions, since it is not monetary fuelled demand-side pull that worries them, but rather commodity induced supply-side push, and in particular the impact this could have on inflation expectations.<br /><br /><b>Credit Tightening Or Credit Loosening? Spain & Germany Compared</b><br /><br />The latest ECB quarterly bank lending survey suggested only a moderate tightening of credit standards for both enterprises and households in the current quarter. But as I am saying, this appreciation of the aggregate sitution conceals significant differences at the individual country level. In Italy, France, Finland and Germany (for example) credit seems to be widely available, while in Spain, Portugal and Greece credit conditions remain very tight. The Bundesbank noted only last week that in Germany there had been a "marked easing of credit standards in lending to both enterprises and households" in the first quarter of this year and that surveyed banks expect little change in credit standards in the current quarter. This view was reinforced by the Ifo Institute who reported that the percentage of German firms which have difficulty accessing credit fell by 1.1 percentage points in April to a record low of 22.6%.<br /><br />Meanwhile in Spain, the central bank state in their latest quarterly report on the economy that notwithstanding the reduced tension in capital market attitudes towards the country, "accessibility by the resident private sector to funding became somewhat tighter".<br /><br />The peculiar thing here though, is that if you look at the comparative inter-annual rates of change the two countries don't seem to be that different.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOiCaVxTT8gUlhFdc5AfhC7l_TwXKs-qm-1FcZBTXcEI25pCrNqf9RuYFDjWLqoEf23qoY2jTiCJ9W4YD-xqDedJx2i85vDNuQGU5aZwHyToDmi7nyvvP9bgJLRsM8HDPU4QjBcFB1BwtH/s1600/German+Total+Private+Sector+Lending.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 247px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOiCaVxTT8gUlhFdc5AfhC7l_TwXKs-qm-1FcZBTXcEI25pCrNqf9RuYFDjWLqoEf23qoY2jTiCJ9W4YD-xqDedJx2i85vDNuQGU5aZwHyToDmi7nyvvP9bgJLRsM8HDPU4QjBcFB1BwtH/s400/German+Total+Private+Sector+Lending.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604360471609111106" /></a><br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj4zuCjcKIZCTKdG-cqY4TG5zGOCJqOMnXXMv5QjbtFpMCgwXiBeeYMaox3UKEY2XmzoKR_-iVoOGZ9xQ9xQvZZs3Gtab5wpYqhLbaAMJJCtSZmGvjqOiNr-dps6b6t8NgyLELfBYm3D8qs/s1600/Spain+Total+Private+Sector+Lending+Y-o-Y.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 248px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj4zuCjcKIZCTKdG-cqY4TG5zGOCJqOMnXXMv5QjbtFpMCgwXiBeeYMaox3UKEY2XmzoKR_-iVoOGZ9xQ9xQvZZs3Gtab5wpYqhLbaAMJJCtSZmGvjqOiNr-dps6b6t8NgyLELfBYm3D8qs/s400/Spain+Total+Private+Sector+Lending+Y-o-Y.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604357079265337426" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEggZCGwEYO0qhJBex7Acfk3ZHTgjLumHerLTJvqUDGXiVGpXttiiAQE95kEPcFE9r_GI8UVe-OuzSNBX3tOPblOrc7YjnFVNasXDpsRGi26DqUz212ZJOQa_zSNvBXS95weO6c1sYKNiRbp/s1600/German+Total+Corporate+Lending+Y-o-Y.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 248px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEggZCGwEYO0qhJBex7Acfk3ZHTgjLumHerLTJvqUDGXiVGpXttiiAQE95kEPcFE9r_GI8UVe-OuzSNBX3tOPblOrc7YjnFVNasXDpsRGi26DqUz212ZJOQa_zSNvBXS95weO6c1sYKNiRbp/s400/German+Total+Corporate+Lending+Y-o-Y.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604360331496731362" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiRqMrB2CY2jisQxsy6N76BUy6awoEDU1DDGg7v5hky9S9c9wAoJCqwxse6bHbweH3Ay8Vpw9MEZxsFG_ZyIWdYxFI0ztc42WiGSqvag81czuZ6AIcspeLTHz50_7rnoEFnIEQKaeFgtve4/s1600/Spain+Bank+Lending+to+Corporates+YOY.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 239px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiRqMrB2CY2jisQxsy6N76BUy6awoEDU1DDGg7v5hky9S9c9wAoJCqwxse6bHbweH3Ay8Vpw9MEZxsFG_ZyIWdYxFI0ztc42WiGSqvag81czuZ6AIcspeLTHz50_7rnoEFnIEQKaeFgtve4/s400/Spain+Bank+Lending+to+Corporates+YOY.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604356963982158306" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgwYPYpSi3WYLervvTbWZZtqBaRosBupSHkI2EKmUmMyPKJM1qdyNZNog7qsB-9mPXj_Vox2iw0b0G0qfcVNKexx9gwQRcYzzp4nNEFJiyndIhJH2AQeTVi93LV_kQoomU75xy-msOgs76J/s1600/German+Total+Mortgage+Lending+Y-o-Y.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 230px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgwYPYpSi3WYLervvTbWZZtqBaRosBupSHkI2EKmUmMyPKJM1qdyNZNog7qsB-9mPXj_Vox2iw0b0G0qfcVNKexx9gwQRcYzzp4nNEFJiyndIhJH2AQeTVi93LV_kQoomU75xy-msOgs76J/s400/German+Total+Mortgage+Lending+Y-o-Y.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604360239464597442" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjlOj8gjYDe-MDj_3Dr0O7yRd0Ohfc2xPmTIFBaOtz1O-Bu-UthdalMCAtj0-K7UiUupDLXNvAPX5LXeSM9JyAmG9qbhO64FRJrsOguugMsG4t_VBrjv19Vj0dYQFmp_WPjyUC6w83zQiiX/s1600/Spain+bank+lending+for+house+purchases+Y-o-Y.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 230px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjlOj8gjYDe-MDj_3Dr0O7yRd0Ohfc2xPmTIFBaOtz1O-Bu-UthdalMCAtj0-K7UiUupDLXNvAPX5LXeSM9JyAmG9qbhO64FRJrsOguugMsG4t_VBrjv19Vj0dYQFmp_WPjyUC6w83zQiiX/s400/Spain+bank+lending+for+house+purchases+Y-o-Y.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604356886911811938" /></a><br /><br />What is apparent is that in each case (Germany or Spain) and regardless of whether or not we are talking about total private sector lending, corporate lending or mortgage lending, the rate of increase in borrowing is extremely low, with the only significant difference between the two countries being that in the German case such extremely low rates of credit growth date back to the turn of the century, while in the Spanish case they area recent phenomenon following the bursting of the housing bubble. (I have dealt with this comparison between Spain and German at greater length <a href="http://edwardhughtoo.blogspot.com/2010/08/on-shoulders-of-giants-how-spain-is.html">in this post here</a>).<br /><br />The big difference between these two countries is, of course, the level of international competitiveness of their economies, since Germany is well able to live with such low levels of domestic credit growth due to its strong export capacity, which enables the country to generate significant GDP growth (currently over 3% annually). In fact, while manufacturing output in Spain struggled to find growth in March, German exports surged to record levels (85 billion euros, 5 billion euros above the pre crisis high hit in June 2008).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhstet4wRuBm7MSZJyffZpjZulljJKEG-oE71R566RS0wKPE8pgbEFgsBFgV5jNN3R1lftO1_S1RiS2De3bbfoPkQh_Vjvp9k4KqMkTkzvmHW9hIYJKMrA98Cat_M8tAWvV3m2zxZOAWb19/s1600/german+exports.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhstet4wRuBm7MSZJyffZpjZulljJKEG-oE71R566RS0wKPE8pgbEFgsBFgV5jNN3R1lftO1_S1RiS2De3bbfoPkQh_Vjvp9k4KqMkTkzvmHW9hIYJKMrA98Cat_M8tAWvV3m2zxZOAWb19/s400/german+exports.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604739601707295538" /></a><br /><br /><br />So as Germany powers forward, Spain's economy has been unable to expand export capacity fast enough to compensate for the sharp loss in domestic consumption, and as a result what little growth there is has been supported by a substantial government fiscal deficit, and even this has still left the economy continually flirting with recession.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-B2UfILXyKIIfZ7rTzgpeQok4Ju_Lc-1uCsxISHWn6devt13qxYSY-KTmp06FTmYIVl2NlcC7puxzymUlPg_mVwF424mmi8FWYOGacxyToGVR3JVhTSRdgidTwib4eyj2mMbdDwmArJJc/s1600/GDP+BdE.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 200px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-B2UfILXyKIIfZ7rTzgpeQok4Ju_Lc-1uCsxISHWn6devt13qxYSY-KTmp06FTmYIVl2NlcC7puxzymUlPg_mVwF424mmi8FWYOGacxyToGVR3JVhTSRdgidTwib4eyj2mMbdDwmArJJc/s400/GDP+BdE.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604657790353545250" /></a><br /><br />Further, in the German case credit conditions are comparatively loose even though there is no great demand for additional credit, while in the Spanish one credit conditions are tight (for a variety of reasons) so potential home-buyers and companies have difficulty getting as much credit as they would like to have, and this despite the fact that prevalent interest rates in both countries are broadly similar, and result from one common monetary policy.<br /><br /><br /><b>And Then There Is Portugal & Greece</b><br /><br />In fact Spain is not unique in this sense, even if the country does offer a somewhat dramatic example of a larger problem. Credit conditions in Portugal are also now tightening, and demand for loans is falling.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0-K5dRo_HWn-h4LVWl2EITpJIlzVXXq0PBlfw1_JGCExhHOVhUHEEqHyXCQgiEtjlQ3F3tHYwDQwTkTxOwEbl6Q0JtcD3AaB3YXSgosZ6Bmskh00C3SvimNVsBHrSmX-CEdcdajBabSO9/s1600/Portugal+Total+Private+sector+Lending.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 212px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0-K5dRo_HWn-h4LVWl2EITpJIlzVXXq0PBlfw1_JGCExhHOVhUHEEqHyXCQgiEtjlQ3F3tHYwDQwTkTxOwEbl6Q0JtcD3AaB3YXSgosZ6Bmskh00C3SvimNVsBHrSmX-CEdcdajBabSO9/s400/Portugal+Total+Private+sector+Lending.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604365332365652626" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiUTWc3wi1Ps6MkPTd5bcg7CtQjam6GUTIR94_X-0w9QwuphBV3T2g8o6vp37R-HLlYey6wyOg6jdFqGep4vSkIRI2GyOjfUZe_w9GZ3WU-TSNZKJkrUTdBal5MBbyx2VHFScLSgWEwmcXz/s1600/Portugal+Bank+Lending+To+Corporares.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 240px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiUTWc3wi1Ps6MkPTd5bcg7CtQjam6GUTIR94_X-0w9QwuphBV3T2g8o6vp37R-HLlYey6wyOg6jdFqGep4vSkIRI2GyOjfUZe_w9GZ3WU-TSNZKJkrUTdBal5MBbyx2VHFScLSgWEwmcXz/s400/Portugal+Bank+Lending+To+Corporares.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604365257031982114" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgfK7Mhh3G7m75VHBBbvyvF3qVchN_nVD1qSCm2SVAStMI4YNfapuX8LtFgUXaZ5R6kv0zsQpJTKOFzdRXs8GsW5V-cV1nOKEP0goH0x7Gf6lU50mxNQ9vhN92cwRFiCc56HFdA2jXyXVcR/s1600/Portugal+Household+Mortgage+Lending.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 239px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgfK7Mhh3G7m75VHBBbvyvF3qVchN_nVD1qSCm2SVAStMI4YNfapuX8LtFgUXaZ5R6kv0zsQpJTKOFzdRXs8GsW5V-cV1nOKEP0goH0x7Gf6lU50mxNQ9vhN92cwRFiCc56HFdA2jXyXVcR/s400/Portugal+Household+Mortgage+Lending.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604365152599130722" /></a><br /><br />And we find a similar picture in Greece.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwtGvoQgN5AGyVs8FJU9HpSJSNHFloYO7cjnGFe4WpHQ9ustHCSe9jaVLQf4QgotmjtiQyvjhMZOr0p1u1U5S92nKa_hiXtjZpPZJsr7u53o9xgm-g5ZhJoZs-5orasAGlWvS9C5HThSoG/s1600/Greece+Bank+Lending+To+Households.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwtGvoQgN5AGyVs8FJU9HpSJSNHFloYO7cjnGFe4WpHQ9ustHCSe9jaVLQf4QgotmjtiQyvjhMZOr0p1u1U5S92nKa_hiXtjZpPZJsr7u53o9xgm-g5ZhJoZs-5orasAGlWvS9C5HThSoG/s400/Greece+Bank+Lending+To+Households.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604366338953795522" /></a><br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgioXxNzyky3laGmptZZu5qnlWC_FFIV9_xY5iuNKDh8K5lbOmX6MG5VjxWZNugiYoEFSiz1bLYHDNDsiaj5MTCAGWhyphenhyphenBQbAjQRP8db4zoMFiX6Uh0vmWpWg4kOWYZ8QjxE3dB9ML8zB_1J/s1600/Greece+Bank+Lending+to+Corporates.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgioXxNzyky3laGmptZZu5qnlWC_FFIV9_xY5iuNKDh8K5lbOmX6MG5VjxWZNugiYoEFSiz1bLYHDNDsiaj5MTCAGWhyphenhyphenBQbAjQRP8db4zoMFiX6Uh0vmWpWg4kOWYZ8QjxE3dB9ML8zB_1J/s400/Greece+Bank+Lending+to+Corporates.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604366043410245522" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiCplSLV-f0wfRxk6RmKBW9uS8XlY_9X5C2AJAzTv-_rCf4Hrq7rC_dhryQcRJRDZ2lel_dVB-OpeAOgo5QnBbFQD7zjKFIEVjtDLk75I5KSrI5QfRyr4prA0OJVlaMg-hoGEi05hSA87EA/s1600/Greece+Bank+Lending+For+House+Purchases.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiCplSLV-f0wfRxk6RmKBW9uS8XlY_9X5C2AJAzTv-_rCf4Hrq7rC_dhryQcRJRDZ2lel_dVB-OpeAOgo5QnBbFQD7zjKFIEVjtDLk75I5KSrI5QfRyr4prA0OJVlaMg-hoGEi05hSA87EA/s400/Greece+Bank+Lending+For+House+Purchases.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604365977976231698" /></a><br /><br />What is most remarkable about these charts for Spain, Portugal and Greece is how they so resemble each other in the sharp decline in credit to the private sector. Nor should any up-tick be expected since all these countries are already heavily in debt, and the only serious way for them to attain sustainable growth is to de-leverage via export-induced saving. That being said, this transition is likely to prove, as we all know, pretty painful. Even during the German transition from 1999 to 2005 things weren't entirely easy, yet these three countries now face a far more difficult and far more demanding challenge, given the scale of their external debt and the current market conditions.<br /><br /><b>Who Needs More QE And Who Doesn't?</b><br /><br />To help them move through that challenging process what they arguably need, in the same way as the UK and the US do, is some form of quantitative easing. Unfortunately excessive reliance on aggregate data leads ECB policy-makers to miss this relatively self-evident fact. So these countries are being asked to make a structural transition of almost monumental proportions without carrying out a competitive devaluation, with accompanying monetary and fiscal tightening. It is hard to see a successful outcome, and indeed I imagine we won't see one.<br /><br /><br />But the monetary union's problems don't end here, since there are another group of countries where monetary easing from the ECB does appear to have been having an impact, and where credit growth has, to some extent taken off. The first of these would be Italy.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQDLFoTVeXPGeMh6BG-xO74dzXkfn72KDxklAYBnsFKCm8DYw-xT2Z7iX_Jv39tyYvifCfeEcxAe6_ArevL09UKX3SkFtjKms8XvMcbbYbn8aTuBDGKa1h4_x5vgQ0Ww8KPCHeNBJCWA7b/s1600/Italy+Total+Bank+Lending+to+Private+Sector+YoY.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 241px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQDLFoTVeXPGeMh6BG-xO74dzXkfn72KDxklAYBnsFKCm8DYw-xT2Z7iX_Jv39tyYvifCfeEcxAe6_ArevL09UKX3SkFtjKms8XvMcbbYbn8aTuBDGKa1h4_x5vgQ0Ww8KPCHeNBJCWA7b/s400/Italy+Total+Bank+Lending+to+Private+Sector+YoY.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604373314859472562" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjjW2-ICNiu8TVB4PX9mWk4RPJkxwpCKtC7qIwssizlsySOBfPTGg4xlkkUzgh3orih56emD8c1STeZrnBxx7wEAYbcQRILz13k_qYvUObc1zjr0X3aEwgLQQ-IhnKsfwlmMJoCRUvFTDZL/s1600/Italy+Bank+Lending+to+Corporates++Y-o-Y.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 239px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjjW2-ICNiu8TVB4PX9mWk4RPJkxwpCKtC7qIwssizlsySOBfPTGg4xlkkUzgh3orih56emD8c1STeZrnBxx7wEAYbcQRILz13k_qYvUObc1zjr0X3aEwgLQQ-IhnKsfwlmMJoCRUvFTDZL/s400/Italy+Bank+Lending+to+Corporates++Y-o-Y.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604373232951090914" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiiklGUKe8TMOc_N9ZoliuXyiSWnX6uWP4rOG8V9kz7ZUUQfxJLCZZS9vbTrM19nBAcZg82hNTRMWxfIPuIOrFJBx3Alkwj5CkufEcqYV_XGapFBFRaftslIMv6bVzhdSeHRFOllFBiNQCO/s1600/Italy+Bank+Lending+For+Mortgages+Y-o-Y.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 240px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiiklGUKe8TMOc_N9ZoliuXyiSWnX6uWP4rOG8V9kz7ZUUQfxJLCZZS9vbTrM19nBAcZg82hNTRMWxfIPuIOrFJBx3Alkwj5CkufEcqYV_XGapFBFRaftslIMv6bVzhdSeHRFOllFBiNQCO/s400/Italy+Bank+Lending+For+Mortgages+Y-o-Y.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604368990833422322" /></a><br /><br />Now there is little to alarm us here, since Italy's private sector is not especially indebted, but it is interesting to see how the pattern varies, and how credit conditions in Italy are very different from those elsewhere in Southern Europe. On the other hand, if we move across the continent to Finland, once more we find little sign of difficult credit conditions:<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiPDRzl3d1M2b1hkYIGxkbCfUgi1mg68m1pYVLJ5BevT6G52U3y0DhtQGccX9Pcyxv2O6TOtXVwVsCDV9VAvZ2kW5qhx7nW4vxuqhZHJJp5g68XamcgEmHT149P4lbzAoJ8id6vFUOJ_gk-/s1600/Finland+Bank+Lending+To+Private+Sector+%2528Total%2529.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 240px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiPDRzl3d1M2b1hkYIGxkbCfUgi1mg68m1pYVLJ5BevT6G52U3y0DhtQGccX9Pcyxv2O6TOtXVwVsCDV9VAvZ2kW5qhx7nW4vxuqhZHJJp5g68XamcgEmHT149P4lbzAoJ8id6vFUOJ_gk-/s400/Finland+Bank+Lending+To+Private+Sector+%2528Total%2529.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604375082919134418" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhw0OyWBYm61BZWHRJ2Pvg5OZAFh_Migl6wyTz9CgGcyQoosfrC3OOt_-z-C-abHr05Rfp1NwlQlfGAaPQ-HG1jyNA9c_jZgOByU3wPCpaltjT9_h1pTvH8FmbG9L0dMeAoBcGV-4DXD9xD/s1600/Finland+Bank+Lending+To+Corporates.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 240px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhw0OyWBYm61BZWHRJ2Pvg5OZAFh_Migl6wyTz9CgGcyQoosfrC3OOt_-z-C-abHr05Rfp1NwlQlfGAaPQ-HG1jyNA9c_jZgOByU3wPCpaltjT9_h1pTvH8FmbG9L0dMeAoBcGV-4DXD9xD/s400/Finland+Bank+Lending+To+Corporates.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604374945014286274" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEit5wDhJ5LjO6ES8HwO89dHGel516OzPc9KMZSZgpyVEPX9HU-pwM81V-itp3X9kCRBzW5AqGFOCn0u2kUFRzowullcl9OHWENH4l96EEm9IO8lfpCHmvH1I5A0P0OVmc7bYqa6UHppsym2/s1600/Finland+Bank+Lending+For+Household+Mortgages.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 240px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEit5wDhJ5LjO6ES8HwO89dHGel516OzPc9KMZSZgpyVEPX9HU-pwM81V-itp3X9kCRBzW5AqGFOCn0u2kUFRzowullcl9OHWENH4l96EEm9IO8lfpCHmvH1I5A0P0OVmc7bYqa6UHppsym2/s400/Finland+Bank+Lending+For+Household+Mortgages.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604374864887980834" /></a><br /><br />Indeed, the low interest rate policy of the ECB during the crisis really does seem to have worked in the Finnish case, in that housing demand and private consumption never really collapsed (<a href="http://edwardhughtoo.blogspot.com/2010/10/bubble-trouble-in-finland.html">see this earlier post on the property boom in Finland</a>). Finally, in this brief survey, there is France, where even though corporate borrowing remains restrained, demand for consumer and housing credit seems to be really kicking back to life.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj6pFGGvKbPpEnxtS7v82MfH7St4UhZVi1MA3oCUdRkzUHoNL_sBSlnqtsXS1C-LKmzAYcNJ9i4RPtPBNGoL-Ls_adkURTWt6SvnjiElJWxKoZWAkLp-SVdqABW1FfByPza58cHruVMy5_8/s1600/Frnace+Bank+Lending+To+Households+Y-o-Y.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 240px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj6pFGGvKbPpEnxtS7v82MfH7St4UhZVi1MA3oCUdRkzUHoNL_sBSlnqtsXS1C-LKmzAYcNJ9i4RPtPBNGoL-Ls_adkURTWt6SvnjiElJWxKoZWAkLp-SVdqABW1FfByPza58cHruVMy5_8/s400/Frnace+Bank+Lending+To+Households+Y-o-Y.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604376551617625522" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgl5RyIYJLRj4u3x6K7Dlvu-TinAwA-XB786VJgTzUJkPOZCKDznloYuZsEQFO5uaWPqsfRArH-w1Ved7eOxsdObGUo8ECe-03sgy0VPTi5PRkozU_jL-nFWbfOLhMPd1hso7W9CPH4tejE/s1600/France+Corporate+Lending+Y-o-Y.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 247px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgl5RyIYJLRj4u3x6K7Dlvu-TinAwA-XB786VJgTzUJkPOZCKDznloYuZsEQFO5uaWPqsfRArH-w1Ved7eOxsdObGUo8ECe-03sgy0VPTi5PRkozU_jL-nFWbfOLhMPd1hso7W9CPH4tejE/s400/France+Corporate+Lending+Y-o-Y.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604376372500458610" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi3bg1-J1y8TQV2fG081YaIMbjORcGt8p7-boh2PIAK0zLHpCDlRdpFL27YXJ70ZPu9cv5tLjFTRVeFhH05hqgf-qb76OcqGoKnNqMmnhTKZvJN8nEstxnc-ueryrqlIZF1e_rJcEC0Yj80/s1600/France+Mortgage+Lending+Y-o-Y.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 246px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi3bg1-J1y8TQV2fG081YaIMbjORcGt8p7-boh2PIAK0zLHpCDlRdpFL27YXJ70ZPu9cv5tLjFTRVeFhH05hqgf-qb76OcqGoKnNqMmnhTKZvJN8nEstxnc-ueryrqlIZF1e_rJcEC0Yj80/s400/France+Mortgage+Lending+Y-o-Y.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604376248056576162" /></a><br />Evidently France is becoming a very special case, since France's private sector is not heavily indebted, although looking at its comparatively young population profile it could easily become so. If there is one country where a property bubble could be produced, that country is France - for both demographic and low-indebtedness reasons (just look at the line of take-off for household mortgages in the above chart). So evidently, at least in the French case ECB tightening makes perfect sense, as it does when we look at the inflation expectations chart.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi60LIEwU7vQyrteLAVpTg1l4cBW6LeWG3aA0tQyVDIenaVf3UFvsAz4My8GbopmTvZ-5tY1as0gqcnd28zU4Ppz4aoVzE4smpTg3mTXf1T21a3r3EYxQGaZ2VxUngIN5r_IGxLAezL7f71/s1600/France+Inflation+Expectations.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi60LIEwU7vQyrteLAVpTg1l4cBW6LeWG3aA0tQyVDIenaVf3UFvsAz4My8GbopmTvZ-5tY1as0gqcnd28zU4Ppz4aoVzE4smpTg3mTXf1T21a3r3EYxQGaZ2VxUngIN5r_IGxLAezL7f71/s400/France+Inflation+Expectations.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604383649427337122" /></a><br /><br /><b>So Just How Many Sizes Do We Need To Fit All?</b><br /><br />The purpose of this brief survey of credit conditions in a number of individual Eurozone countries has been to draw attention to one rather neglected area of policy difficulty. It is common knowledge that having a "one size fits all monetary policy" can prove problematic, in that the application of negative interest rates to an economy that is essentially booming can lead to significant structural distortions, and even produce asset bubbles of one class or another.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgFYqmWG6ULBejXfKgOAuAdlpLhW082VIcjWGaKBcvz5X4D3TLFMcESGX2G2GkaxQzLhSmDHwaeRtjm6FaowNjG-XENhmLVeENWluvrVQtbbkAbEsWlpdibvv5czzLqknS0yhyphenhyphen0ayZY6foO/s1600/CPI+and+ECB+interest+rates.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 255px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgFYqmWG6ULBejXfKgOAuAdlpLhW082VIcjWGaKBcvz5X4D3TLFMcESGX2G2GkaxQzLhSmDHwaeRtjm6FaowNjG-XENhmLVeENWluvrVQtbbkAbEsWlpdibvv5czzLqknS0yhyphenhyphen0ayZY6foO/s400/CPI+and+ECB+interest+rates.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5604665654576646914" /></a><br /><br />But the issue of credit conditions and credit availability is normally given far less attention, even though it is an equally important one. It is clear that it is hard to identify one common "credit cycle" among the zone's diverse economies, and indeed the need for credit is always going to be very different in an economy which runs a large and continuing external surplus when compared with an economy (like France's) where domestic consumption remains strong and the country continues to run an external deficit.<br /><br />It is clear that some of the difficulties which were likely to be faced by countries attempting to handle the rigidities associated with participating in a common currency were well anticipated in advance, even if few of those involved in setting it up were able to listen at the time of its creation. Other problems which were not so clearly foreseen have emerged with time. The difficulty presented by surrendering powers from your own central bank with respect to monetising government debt is only now becoming clear, as is the problem created by acquiescence in the kinds of structural distortions which permit the accumulation of high levels of external debt, debt which fickle markets may suddenly decide they are no longer willing to support. The fact that cheaper interest rates might lead to larger fiscal deficits and growing government debt was foreseen, but the danger presented by ever larger private indebtedness funded by external borrowing surely was not.<br /><br />However, the problems entailed by the absence of any meaningful common credit pattern and the consequent difficulty of maintaining the core idea of ongoing convergence raises perhaps one of the most serious obstacles to Euro credibility and continuity, since, as I try to argue at the start of this study, even the issuing of Eurobonds and the creation of a common fiscal treasury can only represent a stopgap measure in such a situation given that what this then produces is a constant and ongoing transfer of resources from one set of countries to another. This outcome is neither sustainable nor is it desirable, since voters in the funding countries will eventually grow tired of it (even under the rather dubious hypothesis that they were willing to entertain it in the first place) while those who are funded would find themselves in the unpleasant situation of having their long term dependency institutionally re-inforced, even as they find themselves watching a steady trickle of their educated youth moving towards the funding countries in search of better remunerated work.<br /><br />Basically it is not clear at this point whether this growing mountain of associated system-management problems really is capable of being resolved, but one thing is surely very evident, and that is that not talking about them won't make them go away. It really is high time the ECB stopped boxing itself into a corner by examining monetary policy impacts only at the aggregated data level, and started to analyse and identify policy implementation impacts at the individual country level. Simply throwing the issue back to the various national governments by saying "this is your problem, what you need are more structural reforms" is no response at all. This will be especially true if the proposed structural reforms prove not be sufficient to handle the scale of the problem, since this will only produce an even greater loss of confidence in the Euro than that which has been sustained to date, precisely the outcome that ECB governing council members must be anxious to avoid. Or will we be told that the structural reforms implemented simply were not deep enough. What has been argued here is that the idea of a common Eurozone-wide credit cycle associated with ongoing convergence between member state economies could be regarded as a "crucial simplifying assumption" in the sense used by Robert Solow in the quote at the start of this study, an assumption which underpins the whole theoretical apparatus on which the common currency is based. The question is, after ten years of operation, does this assumption still remain plausible and reasonably realistic?Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-85252589547580951032011-05-03T05:03:00.000-07:002011-05-03T05:22:36.008-07:00Japan's Economy Struggles For Airby Edward Hugh: Barcelona<br /><br />With the arrival of the first real Japanese data since the Tsunami struck the immensity of the tragedy which Japan is passing through is only now gradually becoming apparent. Exports were down by a seasonally adjusted 7.7% in March over February, while imports were only fell by a much more modest 1.4%, with the inevitable consequence that the trade surplus which forms the lifeline for Japan's fragile economy shrank sharply. In particular car production was badly hit, with output at Toyota plunging 62.7% during the month, while Nissan reported a drop of 52.4% and Honda put the shrinkage in its Japanese domestic production at 62.9% adding that output would be at 50 percent of its former projections until at least the end of June.<br /><br />In fact March output across the whole of Japanese industry fell at a record monthly pace of 15.3%, while household spending declined at the record annual rate of 8.5%.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiPzUh-ixwBU4mBKdlcwA3SorUyv5akbtJIRlxDBuKk5FIDbvjsj-w-iOLmkXBikM7UJEEryUUy3vQ1ptYohIpBDK6G_Oh6bm7mgwNtFjPHaNTGHss90vtG7D_PEJqfJAGZgPfk8rOZYhxx/s1600/japan+IP.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 224px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiPzUh-ixwBU4mBKdlcwA3SorUyv5akbtJIRlxDBuKk5FIDbvjsj-w-iOLmkXBikM7UJEEryUUy3vQ1ptYohIpBDK6G_Oh6bm7mgwNtFjPHaNTGHss90vtG7D_PEJqfJAGZgPfk8rOZYhxx/s400/japan+IP.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5601685942787732978" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTlBigyXGypG9nD9CPKcX7yTpxfXVm9oJ7x57Y06uMLzcMNXMQLFIAQp0b1jZwiRjL4dopR4izSgAOqHVrs1m4NuVEwR6MpUdpG-l3RG1cMd9Ib76S7NYPC6Xi-6-m4TfH5WNKP5dQScmX/s1600/household+consumption.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 206px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTlBigyXGypG9nD9CPKcX7yTpxfXVm9oJ7x57Y06uMLzcMNXMQLFIAQp0b1jZwiRjL4dopR4izSgAOqHVrs1m4NuVEwR6MpUdpG-l3RG1cMd9Ib76S7NYPC6Xi-6-m4TfH5WNKP5dQScmX/s400/household+consumption.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5601689899011912562" /></a><br /><br /><br />Large as they are, however, these numbers were to some extent expected. More worrisome from the Japanese point of view is the fact that production may be many months getting back to earlier levels given supply chain problems and the fact that electricity generating capacity will remain problematic, leading to reductions in the level of power available. These delays in restoring production in Japan’s auto industry at a time of substantial economic growth in potential new markets raise the prospect that some of the damage may be permanent, as some part of the Japanese market share goes to the country’s main competitors. Indeed just this point was raised by S&Ps recently <a href="http://www.marketwatch.com/story/sp-cuts-japanese-auto-outlook-to-negative-2011-04-25">when they cut their outlook to negative</a> for all three manufacturers along with suppliers Aisin Seiki, Denso, and Toyota Industries. In their report justifying the move S&P’s stated "The outlook revisions also reflect our opinion that extended production cuts may erode Japanese automakers market shares and competitive positions in the longer term."<br /><br />Among companies who may well inadvertently benefit from Japan's ill fortune is the US company General Motors, who less than two years after declaring themselves bankrupt <a href="http://www.bloomberg.com/news/2011-05-03/gm-rises-to-no-1-on-china-sales-toyota-can-t-match-after-quake.html">now seem poised to reclaim the global auto sales number one spot from their struggling rival Toyota</a>. Japan's car manufacturers have also been hurt by the sharp rise in the value of the yen. After years of a weak yen boosting sales and corporate profits, the Japanese currency has steadily strengthened to 81 yen to the dollar from 112 at the end of 2007. What might have been seen as a temporary development now looks much more permanent, and strategic planning by Japanese corporates will undoubtedly be influenced by this when it comes to decisions on where to locate new plant and capacity. And in the meanwhile, they stand to loose market share in both the US and in the key growth market, China.<br /><br />German manufacturing is also an indirect beneficiary of Japan's ills, and the German April manufacturing PMI once more revealed a very strong performance, underpinned by ex-European demand for capital and intermediate goods.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjx4SfsoxCB6Cf6VKWZJAoFm9Hsf083KXqLgahay_pyB1TXN9xYwqCegTwmeXpGmLBSmxBYhDuDkynEuPyJO0vLEfGs8QxT0rb4hDcEskIj2reaWSPY9VGryTJa_pAmsAkLA-8HsnyuO4yH/s1600/German+manufacturing.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjx4SfsoxCB6Cf6VKWZJAoFm9Hsf083KXqLgahay_pyB1TXN9xYwqCegTwmeXpGmLBSmxBYhDuDkynEuPyJO0vLEfGs8QxT0rb4hDcEskIj2reaWSPY9VGryTJa_pAmsAkLA-8HsnyuO4yH/s400/German+manufacturing.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5602458344836703714" /></a><br /><br />Obviously the substantial under-performance will continue, as was confirmed by the April manufacturing PMI which showed a second month of sharp contraction, with the indicator registering 45.7 reflecting a deterioration on the already sharp contraction (46.4) registered in March (50 marks the neutral, or no change mark on these indexes). And while after years of deflation and slow growth Japan’s economy may not be what it used to be, it is still the world’s third largest economy, so it should not surprise us if JPMorgan attributed a large part of the fall in their March Global Composite PMI (to a six monthly low of 54.7) to the Japan impact. Without the contraction in Japan, they suggest, the Global Output Index reading would have been in the region of 57.3.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9kQ_LWJOkv1K6XrcWRRbkHSWvRSLGoRLPZHqJpewR-CdCWWHBDbGTt6xdYG_EKGf82h8S9F4iX6QtXIif9pzpQtjPTOCbT9mN3NyCdj9YH4DUlXlaWvZuyB-WFFeQp-2uCxE5qsgEM5nb/s1600/gdp+four.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 197px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9kQ_LWJOkv1K6XrcWRRbkHSWvRSLGoRLPZHqJpewR-CdCWWHBDbGTt6xdYG_EKGf82h8S9F4iX6QtXIif9pzpQtjPTOCbT9mN3NyCdj9YH4DUlXlaWvZuyB-WFFeQp-2uCxE5qsgEM5nb/s400/gdp+four.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5602458739792629794" /></a><br /><br />On the other hand, since Japan is an export surplus country, and it is highly likely that the slack left by Japan’s export losses will be taken up by its main competitors, beyond a short-lived supply chain blip there is unlikely to be any major impact on Global economic growth in 2011 following from the disaster. The problem here is very much a Japanese one.<br /><br />We also now have details of the first instalment of money allocated by the government for the reconstruction programme. As expected the initial spending is modest in relation to the extent of the damage, <a href="http://www.bloomberg.com/news/2011-05-02/japan-passes-49-billion-disaster-reconstruction-package-with-more-to-come.html">with an emergency budget of 4 trillion yen ($48.5 billion) while total costs have been estimated as lying more in the region of $300 billion</a>. Further, the government have been at pains to stress that no new debt will be issued to cover this spending, and that the resources will be found from cuts in social programmes and from pension fund resources. In fact the package has been financed using 2.5 trillion yen from the country's pension funds plus money originally intended to increase payments to families with children. Ironically this money had been promised as part of a campaign to try to address the country's long term demographic shortfall, which is now playing a key role in generating the country's evident economic imbalances. In any event, these are hardly "stimulus" measures, although paying for the next round of reconstruction will be much harder without recourse to a new debt issue.<br /><br />Significantly, no decision seems yet to have been taken on whether to increase consumption tax, since given the ongoing weakness in Japan domestic consumption the application of such a remedy in the current environment may create as many issues as it resolves. The reticence of the Japanese authorities to raise new debt is comprehensible given the fact that the IMF estimates that gross government debt will hit 229% of GDP in 2011 (and net government debt 128%) while the rating agencies are waiting in the wings waving imminent downgrade warnings. Subsequent packages are likely to prove far more challenging in terms of financing, and markets are liable to remain nervous.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEir38F-39xyRidY-KsNx06QMSDHnewVBLg1foIhI5AHyEEaJm1EsaFGIbhQEn9WX6xSIyVWMo0sHcwDJkBax1Lz0kIdl30gI-eQ2kiExBo03mzaTYqT-mW0sZcE7qcvCnR0y7PNlONXVUeb/s1600/Japan+Government+Debt.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 247px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEir38F-39xyRidY-KsNx06QMSDHnewVBLg1foIhI5AHyEEaJm1EsaFGIbhQEn9WX6xSIyVWMo0sHcwDJkBax1Lz0kIdl30gI-eQ2kiExBo03mzaTYqT-mW0sZcE7qcvCnR0y7PNlONXVUeb/s400/Japan+Government+Debt.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5602448795249701090" /></a><br /><br />It is now more or less universally acknowledged that Japan is in recession, and Bank of Japan governor Masaaki Shirakawa has confirmed this impression by asserting the Bank’s view that the economy will continue to contract throughout the first half of the year. In fact <a href="http://news.yahoo.com/s/nm/20110430/bs_nm/us_japan_economy_shirakawa">only last Saturday he described the country's economic outlook as "very severe"</a> and asserted that the central bank was resolute in its determination to take appropriate action to support the economy. Most observers interpret this as meaning that the bank will ease further by increasing its asset purchase programme. The BOJ eased policy in the days following the tsunami by doubling to 10 trillion yen the funds it sets aside for purchases of a range of financial assets, such as government bonds and corporate debt, and despite the fact that a proposal from Deputy Governor Kiyohiko Nishimura to expand the programme by 5 trillion yen ($62 billion) was outvoted by the board, the mere fact it was discussed could mean that bank could loosen policy further as early as next month.<br /><br />It is important to bear in mind that Japan’s recovery from the global crisis was always fragile, and that while post-Lehman growth resumed in Q2 2009, the economy contracted again in Q3 2009, and suffered a further relapse in Q4 2010. At the end of last year economic activity in Japan was still at the same level as in Q1 2006, and the short term impact of the Tsunami will only have served to blow it further back in time.<br /><br />Thus while it seems pretty clear that growth in Japan will resume in the second half of the year, and that the rebound in manufacturing industry will be pronounced once a normal power supply is restored, the thesis that natural disaster shocks are invariably good for economies with a lethargic track record of pronounced under-performance seems rather questionable. It is entirely possible that Japan will turn into a reference-case-example of a country where this does not happen (particularly given the major differences in the demographic profile between Post WWII Japan and the country today). In addition, while additional government indebtedness and burden sharing from the private sector may well be short term growth positive, the stimulus will be short lived, since what Japan needs is not a “one off” push start, but major structural changes and in particular a new openness to immigration. Further down the road only lie major tax increases (which will surely slow the domestic economy even further) or (ultimately)debt restructuring, since surely, even in the Japan case, the sky is not the limit for sovereign debt, and while any Japan sovereign restructuring would have little external impact given that the Japanese are the main holders of their own debt, Japan's banks (who hold the lion's share) would hardly escape unscathed. But beyond immediate government debt-woe issues, the big question is the extent to which lasting damage is being done to demand for Japanese home-grown products, and whether or not this will make it more rather than less difficult to sustain in the longer term the external surplus the country so badly needs to underpin its fiscal survival.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-58284788793520019482011-04-17T08:06:00.000-07:002011-04-17T08:07:13.199-07:00Debunking the Demographics Irrelevance Proposition<div class="body"> <p>By Claus Vistesen: Hull<br /></p><p>In a seminal paper [1] from 1958 Franco Modigliani and Merton H Miller showed why investors should not care about whether firms were financed with debt or equity. This led to the idea of the the debt irrelevance proposition and although the DIP is a theoretical benchmark rather than a real world rule the 1958 paper by Modigliani and Miller remains a key contribution to the finance literature. We should not however extend the same role to the recent attempt by researchers [2] to re-invent the DIP in a new guise replacing "debt" by "demographics". Allow me to explain why.</p> <p> </p> <p><strong>Demographics, Just Forget About It ...<br /></strong></p> <p>My point of departure is Edward Chancellor's recent GMO letter in which he tackles what he considers to be the non-issue of Japan's dire demographics. He emphasizes two things; firstly, that economists are notoriously poor at predicting demographic variables and secondly he notes that whatever relevance demographics might have for macroeconomic analysis at large (of which Mr Chancellor appears skeptical) it is irrelevant for the investor;</p> <blockquote> <p>Besides, long-term demographic forecasts aren’t particularly relevant for equity investors. It’s true that changes in the population have a sizable impact on GDP growth. But stock market returns are not positively correlated with economic growth. Returns from equities are a function of valuation and future returns on capital – a subject to which I will return later – rather than changes in GDP. Nor is there a positive correlation between population growth and stock market returns. In short, investors should not get too hung up on inherently unreliable long-term demographic projections for Japan.</p> </blockquote> <p>It is important to underline, in fairness to Chancellor, that the points are made with specific focus on Japan but the the argument seems to have a more general hue. This is even more obvious in relation to one of Chancellor's main references in the form of Morgan Stanley analyst Alexander Kinmont's note entitled <em>The Irrelevance of “Demographics”? </em>Kinmont puts up the following four points which I will use as my points of reference;</p> <blockquote> <p>1. It is not clear that demographic estimates are accurate over long time frames. In fact, while spurious specificity is one of the attractions of demographics as a talking point, the fact that neither death rates nor birth rates have proven predictable should caution one against accepting any assertion about demographics.</p> <p>2. It is not clear that demographics are the critical variable in determining the level of economic growth. That role falls to the growth rate of TFP.</p> <p>3. It is not clear that equity returns are related to absolute levels of growth. Equity returns are an issue of valuation. Nominal returns are greatly affected by inflation too.</p> <p>4. It is not clear that demographic change, even if it is allowed as a negative for economic growth, is necessarily negative for stocks, as certain forms of demographic change may be associated with a rising equity market multiple. Demographic change could in fact represent a benign environment for stocks.</p> </blockquote> <p>On the first point Kinmont makes points to the irony in that the worry about Japanese demographics seems to be peaking just as Japanese fertility is on the mend. This is a cheap shot though and not one which stands up to scrutiny. First of all on the fertility trend itself I get the same chart as Kinmont's below using data from the World Bank showing a rebound in Japan from a low point of 1.29 in 2003 and 2004 to 1.37 in 2009. However, <a href="http://www.indexmundi.com/japan/total_fertility_rate.html">Indexmundi</a> which takes its data from the CIA World Factbook has fertility much lower and actually declining in Japan. <a href="https://www.cia.gov/library/publications/the-world-factbook/fields/2127.html?countryName=Japan&countryCode=ja&regionCode=eas&#ja">The latest data point from the CIA World Factbook</a> reports an estimate of TFR in 2011 is 1.21. This is a pretty steep difference and I invite comments as to suggest the right number or at least the right trend.</p> <p><em>(click on picture for better viewing)</em></p> <p style="text-align: center;"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhDUQLILJVILccicgx5T4u_Q4M5lpHhkD_cKfSTd3UYkd_YpSWtX_t3KjMo1_h8tOjY3Zl-rM1lmP0TQDuWWbpaD5q_OHz2UvTU-lRXQN13dg7jSH9C4EHDHmEWSRrhTzsa56TwGQFFcuTf/s320/kinmont+japan+TFR.JPG?__SQUARESPACE_CACHEVERSION=1303027056396" alt="" /></p> <p>All this is of course underlines Kinmont's point that we don't know the future and that economists have a proven track record for abysmal forecast performance. Still, we should get our concepts right at the offset. Long term projections in <em>age structures</em> are likely to be robust as they are a function of people already being born and while migration may change the course of ageing in any given country the fact that we are all ageing at one at the same time means that there are fewer migrants to go around. I would then claim that ageing does matter and that understanding how an economy such as Japan adapts to the ageing of its population remains one of the most vexing and important issues for social scientists and investors alike.</p> <p>So when Kinmont implies that low fertility in Japan is a non-issue I have to strongly oppose. Just take a look at the chart above Kinmont himself uses. Fertility has been below replacement levels in Japan since 1970 and on current growth rates (assuming a constant growth rate of fertility which in itself is dubious to the extreme) fertility levels would reach replacement levels some time in 2030-40. So, that would be 60 years with below replacement fertility. Even if fertility in Japan (and again in most of the OECD) took a discrete jump to replacement levels it would do very little to change the outlook for ageing in the immediate future.</p> <p>In claiming that demographics do not matter Chancellor are Kinmont are taking a very wide brush over the general recognition in the academic literature that our economic systems tend to hit a snag once fertility falls below a certain level (a TFR of 1.5). This is also called a <a href="http://demographymatters.blogspot.com/2007/05/fertility-trap-hypothesis-revisited.html">fertility</a> <a href="http://demographymatters.blogspot.com/2006/08/low-fertility-trap.html">trap</a> and what it means is that it becomes very difficult to escape negative population dynamics once they set in. I emphasize this since it highlights that we are not, as a friend of mine likes to point, simply shooting arrows into the void when we point to the importance of these issues. I recommend <a href="http://www.oeaw.ac.at/vid/download/pce/dec01/pm/Low_Fertility_Trap_01_12.pdf">the following presentation by Wolfgang Lutz</a> et al and <a href="http://www.oeaw.ac.at/vid/download/edrp_4_05.pdf">the paper</a> that goes with it or <a href="http://fistfulofeuros.net/afoe/the-low-fertility-trap/">this old post at AFOE by Edward</a> if you are still not convinced.</p> <p>In terms of the postulated increase in Japanese fertility since the mid 2000 it is a positive development, but as is evident from the data this rebound is extremely uncertain. In addition, we need to know whether this is just an echo of the tempo effect (and thus how large the rebound is likely to be) or whether it reflects a real change in attitudes on quantity. I am open to contributions here but the only thing we can for certain is that ageing, in Japan and the rest of the OECD, will continue its march onwards. Here I also feel that Kinmont puts up a straw man when he invokes the idea of Japan's population going to zero;</p> <blockquote> <p>The unrevealed assumption, then, behind the mathematics used to arrive at widely-used population estimates is that the Japanese population will drop to zero. One cannot help but suggest that the logic of demographic pessimism is circular.</p> </blockquote> <p>I want to re-emphasize that the issue here is <em>not</em> predicting fertility and death rates but recognizing the effect that the current and past trends have on ageing today and tomorrow. Try <a href="http://clausvistesen.squarespace.com/alphasources-blog/2009/7/19/global-population-ageing-what-do-we-know.html">the recent work by Wolfgang Lutz, Warren C. Sanderson, and Sergei Scherbov</a> if you want to see the cutting edge here and while uncertainty is still a key variable ageing remains a tangible reality. The main question issue I would like to get across is then that the demographic transition manifests itself in a transition of ageing and that this essentially becomes our main unit of analysis.</p> <p> </p> <p><strong>Growth and Demographics, No Connection? </strong></p> <p>Kinmont and Chancellor argue that demographics are likely to be less important for growth over time as total factor productivity (TFP) growth tends to be the main driver of growth.</p> <blockquote> <p>Japan could quite easily grow at a good rate, especially in per capita terms, for a high-income developed country even in the face of a falling population (or more precisely a falling working age population). All that is required is for TFP growth to accelerate back to the level of growth enjoyed by Japan prior to the bursting of the Bubble in 1989. TFP slowdown preceded the population peak. Variation in TFP performance not in labour input growth is likely to be larger than the negative effects of population change.</p> </blockquote> <p>This is an important point and more importantly, Kinmont offers an argument to explain the declining labour input in Japan’s economy which links in with the fact that Japan has been stuck in deflation and at the zero lower bound for the best part of two decades (my emphasis).</p> <blockquote> <p>Labour input has in fact fallen at an accelerating pace over the past 20 years. It is clear that the fall is principally a decline in man-hours. This cannot be simply a function of a decline in the working age population because that decline only began in 2000. Instead, its origins must lie in rising unemployment and under-employment. <strong>A persuasive new paper, The Paradox of Toil, by a researcher at the NY Fed [3] argues that a decline in labour input is a natural consequence of a deflationary economy with zero (or effectively zero) interest rates</strong>.</p> </blockquote> <p>In short, the declining labor input in Japan is a function of deflation and being stuck at the zero lower bound. In addition, this Fed Researcher Kinmont refers to is Gauti Eggertson who studied under Krugman at Princeton and did most of his initial work on the liquidity trap and the zero lower bound. So, I would be careful getting in his way without a strong look at the argument.</p> <p>I think however that we might be dealing with the problem of a missing link in the sense that demographics may be one of the <em>primary</em> sources of deflation and the liquidity trap in the first place. This is an argument that has been pushed in Japan’s case in the sense that it was a lack of pent up demand that held Japan back in the 1990s as well as deleveraging. Indeed, Japan may hold a cautionary tale on the effects of a balance sheet recession in an economy where fertility has been below the replacement level for an extended period. The Eurozone periphery (ex Ireland) who have even ceded monetary policy to Frankfurt are case studies to this theory I think.</p> <p>I would also emphasize that as labour input declines so does, obviously, consumption (aggregate demand) input which again feeds into the the paradox of thrift in the closed economy (or perhaps even a realisation crisis?). In an open economy it leads to export dependency as domestic investment actvity responds to foreign demand as well as the excess income you earn from a positive net foreign asset position (if you are so lucky as to have one) becomes a crucial source of growth.</p> <p><span lang="EN-GB">Another more fundamental point is that if the total factor productivity growth (TFP) is a residual what is actually hidden in this residual? Well, <a href="http://www.creditwritedowns.com/2010/06/demographics-and-macroeconomics-part-1-wonkish.html">I had a wack at the whole argument</a> a while ago from the perspective of the academic armchair. </span></p> <blockquote> <p>Technology and productivity are famously assumed exogenous in the Neo-Classical tradition while New Growth theory as it was developed in the 1980s and 1990s emphasised the need to specifically account for the evolution of technology. Today, I would venture the claim that there is a consensus that productivity and technology is a function of what we could call, broadly, institutional quality which encompass almost anything imaginable from basic property rights to the level of entrepreneurship. Indeed, a large part of research is still devoted to pinning down exactly which determinants that are most important here both across countries and through time. Now, I would argue that, in the context of standard growth theory, this is where the scope for the study of the effect of population dynamics is largest. Thus I don’t think it is unreasonable to expect the level and evolution of productivity growth and technological development to be a function of the current population structure but also its velocity which is a function of e.g. migration (new inputs?), future working age size etc. Also, this is also where human capital and the evolution of technology is joined at the hip through the idea of innovative capacity and readiness.</p> </blockquote> <p>Once we venture into the notion of endogenous growth theory and thus the attempt to directly explain the sources and components of total factor productivity growth there is growing evidence that age structure/demographics alongside a host of other variables are important. Try <a href="http://clausvistesen.squarespace.com/betasources/2010/10/17/demographic-change-in-models-of-endogenous-economic-growth-a.html">this one</a> for a recent literature review, and for the general link between growth and demographics <a href="http://www.nber.org/papers/w13221">the list</a> <a href="http://www.ecb.int/pub/pdf/scpwps/ecbwp670.pdf">of contributions</a> <a href="http://www.nber.org/papers/w6268">is long</a>. You just need to read around a bit.</p> <p>I would argue then that growth and prosperity of the modern capitalist welfare state is highly conditional on some form of demographic balance and Japan has long since moved beyond into unbalanced territory. Basically, Japan is stuck in a liquidity trap as well as a fertility trap. The latter works along the lines of depressing consumption demand and making it very difficult to maintain key economic structures such as e.g pension systems. In addition, ageing affect the growth path of an economy and leads to export dependency, this last point however which I concede is not yet an established fact in the literature.</p> <p> </p> <p><strong>What about stocks then?</strong></p> <p>We seem to have two intertwined arguments here. Firstly, the extent to which demographics may have an influence on growth it is irrelevant for the investor since you can't buy GDP growth anyway. Secondly, the evidence of a correlation between demographics and equity prices is weak and indeed, if anything, should be bullish for Japan (this last point is made by Kinmont).</p> <blockquote> <p>Thus the FT summarized the latest findings of the London Business School team of Dimson, Marsh and Staunton, as published in the Credit Suisse Global Investment Returns Yearbook, 2010. The LBS academics examined all the available data (83 markets), and concluded that “99 per cent of the changes in equity returns could be attributed to factors other than changes in GDP”. (...) <strong>Growth is not all that it is cracked up to be</strong>. This analysis underscores previous academic findings showing that growth<br />per se to be of only small importance to stocks.</p> </blockquote> <p>It would be unwise to disagree with the gist of this point. Even if I can make a connection between demographics, growth and investor performance it is very likely that buying into such a story at too high a valuation will lead to poor returns. Buying at the right value is the most important aspect of any investment decision. </p> <p>This however is not the same thing as saying that just as you make sure to "buy cheap" poor demographics, low growth etc are completely irrelevant. Rather, I think that the extent to which the modern investor needs to understand a decidedly more complex macro picture with lingering deflation, heightened risk of sovereign defaults and zero lower bounds the understanding of demographic dynamics is key. We are then again discussing the question of deflation and low interest rates in Japan;</p> <blockquote> <p>The origin of Japan’s problems is falling valuation when compared with the rest of the world. When we note in addition that it is excesses of inflation or the arrival of deflation (that is, monetary phenomena reflecting policy errors) which tend to reduce market average valuations, we feel it safe to conclude that demography will have next to nothing to do with the longer-term return profile of the Japanese market either in nominal or real terms.</p> </blockquote> <p>I feel this is a very dangerous claim to make because it assumes that the deflation dynamics of Japan and indeed the problems facing the Bank of Japan in reviving credit growth are unrelated to demographics. In addition there is the unintended consequence of BOJ having to monetize an ever greater amount of JGB issuance in the future which in itself becomes more paramount as Japan ages.</p> <p>On the second point regarding a direct relationship between demographics and stock prices (asset prices in general if you will) I think Kinmont does better especially because he does not fall into the <a href="http://www.investmentmarkets.co.uk/20050317-30.html">asset meltdown hypothesis</a> trap. In short the asset meltdown hypothesis states, in a US context, that as the baby boomers retire they will dissave and thus need to sell off their financial assets to a market which cannot support the flow, because the generation in the working age years is smaller, and that this will lead to an "asset meltdown". Generalized, this is then the classic (and naive) nexus between life cycle economics and financial markets which postulate that dissaving into old age is rapid and imminent.</p> <p>There are two problems here. Firstly, the empirical (and indeed theoretical literature) has found it very difficult to verify that dissaving occur among elderly cohorts to the extent postulated by the standard life cycle theory. Secondly, the relationship between asset prices and broad demographic aggregates appear weak. Results differ from country to country and most studies take place in a US and Anglo-Saxon setting which tend to bias the results further.</p> <p>Kinmont does however point to a study by Geanakoplos, Magill and Quinzili [4] which show how the ratio of the 45-54 age group to the 25-34 age group is closely related to P/E ratios. As this ratio is set to increase in Japan, Kinmont ventures the idea that, if anything, perhaps you would want to buy Japan on the basis of demographics.</p> <p>I have read the research by Geanakoplos et al and I find it intriguing, but my problem is that it does not control for the old age dependency ratio which suggests that the key ratio will be correlated with ageing in general. But I should be hesitant disregarding it on the basis of this hunch. I am preparing a large panel data set at the moment on demographics and stock prices with the aim to essentially rejuvenate a literature which seems too focused on the asset meltdown hypothesis noted above. </p> <p>On a more general level, demographics and investment has been a core theme in the post crisis flow into emerging markets which, by and large, share the characteristics of being in the middle or at the end of their demographic dividend. Again, this does not nullify the importance of valuation and certainly, the recent soft patch notwithstanding, many emerging markets are still looking expensive. </p> <p> </p> <p><strong>Where goes the DIP then? </strong></p> <p>If you build your story up around the notion that investors buy value and not GDP growth you can easily come to the conclusion that demographics are irrelevant for the investor at large. This however would be a mistake.</p> <p>I would be the first to wish for a return to a state of affairs in which investors needed only to look at valuation and firm fundamentals to make their decisions. Today however, you need to understand the macro backdrop and in order to do that you need a firm grip on how demographics affect macroeconomics. Pointing out that we are poor at predicting birth and death rates as well as pointing to weak evidence between growth and demographics do not cut it. We need not predict fertility and mortality but instead we need to understand the effects of ageing already present and there is plenty of evidence that demographics affect the growth rate and growth path of the economy.</p> <p>I am more sympathetic to the strict relationship between stocks and demographics which is fickle and not well understood. Clearly, there is not presently any convincing model or framework which suggests how and why you might be able to buy sound demographics on a beta level. My main bet is that demographics should, at least, be used to qualify the notion of the global market portfolio and especially that demographics be used to re-balance such a portfolio over time.</p> <p>In conclusion, Kinmont and Chancellor bring up some valid and good points in their attempt to brush away demographics as an important input variable to investment and macroeconomic analysis but you shouldn't be fooled. Just as was the case with the original DIP you accept this new version at your peril.</p> <p>---</p> <p>[1] - Franco Modigliani and Merton H Miller (1958) – <a href="http://bbs.cenet.org.cn/uploadImages/200351010534890199.pdf"><em>The Cost of Capital, Corporation Finance and the Theory of Investment</em></a>, American Economic Review 48 (June 1958) pp. 261-297.</p> <p>[2] - GMO White Paper - <em>After Tohoku: Do Investors Face Another Lost Decade from Japan?</em>, Edward Chancellor and Morgan Stanley Japan Strategy - <em>The Irrelevance of “Demographics”?</em>, Alexander Kinmont. I realise that I have lately been referring to sources and pieces of research which by nature of their origin (banks, research firms etc) are behind subscription walls. I am sorry, but I will make sure to produce relevant quotes so that my readers can follow the issues and arguments. I cannot upload full PDF versions of the reports for obvious reasons and I hope my readers will understand.</p> <p>[3] - <a href="http://www.newyorkfed.org/research/staff_reports/sr433.html">The Paradox of Toil</a>, Gauti Eggertsson, Federal Reserve Bank of New York Staff Reports, no. 433, February 2010</p> <p>[4] - <a href="http://economics.ucr.edu/seminars/winter04/02-26-04%20Martine%20Qinzii.pdf">Demography and the Long-run Predictability of the Stock Market</a>. John Geanakoplos, Michael Magill, and Martine Quinzili; August 2002, Revised: April 2004. Cowles Foundation Discussion Paper No. 1380</p> </div>CVhttp://www.blogger.com/profile/16843402165210120665noreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-79990114342171515452011-04-07T10:35:00.001-07:002011-04-07T10:35:30.700-07:00QE and the Wealth Effect<div class="body"> <p>By Claus Vistesen: Hull<br /></p><p>Events in Japan and Libya do not seem to have derailed the ongoing positive sentiment in the market, but it might just have alerted various Masters of the Universe that black holes (or was that swans?) are both invisible and unpredictable until they occur. It is precisely because of this that such events are important even if I think that hedging against so-called "tail risks" by buying specially tailored financial products is probably as effective as buying an extra swim suit in anticipation of the next tsunami.</p> <p>On that note and if there ever was a clearly signalled change in the daily state of the market it is the end of the Fed's QE2 and thus the end of unconventional monetary measures by the Fed. It would then seem to be a simple exercise of discounting information which is already incorporated into current market prices, but it is anything but. This is due to two things in particular;</p> <ul><li>While it is certain that QE2 will end, it is considerably more uncertain whether QE <em>itself</em> will end and it seems as if the market is implicitly expecting a continuation in the form of QE3. But it is not clear cut. The macro picture is brightening in the US and Fed officials are getting more hawkish and what was certain a few months ago, may not be so certain today. In addition, if the perception changes into an expectation of an end to QE <a href="http://ftalphaville.ft.com/blog/2011/04/01/534716/an-exit-strategy-for-the-fed/">the path and pace of the Fed's exit strategy is also uncertain.</a></li></ul> <ul><li>There is considerable uncertainty (and disagreement) as to the exact effect of QE in the first place and this shows itself on two fronts. One is the discussion of whether QE has been a success or not and the second is the more technical (yet equally important) question of through which channels QE can be shown to work (if at all). <a href="http://krugman.blogs.nytimes.com/2011/04/04/the-transmission-mechanism-for-quantitative-easing-wonkish/?smid=tw-NytimesKrugman&seid=auto">Krugman recently suggested</a> the exactly the stock market effect which this post is based on. </li></ul> <p>In order to get to grips with this I thought it would be apt to center my analysis on the horse's own mouth as it were and specifically <a href="http://www.financialsense.com/contributor/david-moenning/forget-rates-is-the-fed-targeting-stock-prices">the idea that </a>the <a href="http://www.tradersnarrative.com/bernanke-op-ed-federal-reserve-targeting-stock-prices-4983.html">Fed is targeting stock prices</a>. Obviously, if asked directly Bernanke and his colleagues would certainly point out that it is not all about stock prices but a much more complex issue of affecting rates on all maturities of the yield curve as well as to repair the the monetary policy transmission mechanism as well as the monetary multiplier.</p> <p>Yet, given chairman Bernanke's comments that the success of QE2 is linked to rising stock prices I thought it would be interesting to have a look at the macroeconomic effect of rising stock prices and thus the idea of the wealth effect. This is to say, what is the effect of rising stock prices on personal consumption expenditures and thus, in some sense, growth?</p> <p>In summary, my analysis gives the following hints to the wealth effect in the US</p> <ul><li>The wealth effect from the stock market in the US is time variant but appear to be particularly strong in the period 1999 to 2010 which, in some sense, validates the Fed's focus on stock prices.</li></ul> <ul><li>The wealth effect also shows up in a negative relationship between changes in the SP500 and changes in the saving rate which suggest that rising asset prices may counteract deleveraging. </li></ul> <ul><li>The fiscal multiplier estimated here is also time variant and seems to change signs across periods. </li></ul> <ul><li>The marginal propensity to consume seems to have risen over time in the US.</li></ul> <p>Here, the two last bullet points are secondary to the main focus of this note but still worth thinking about.</p> <p><em>(click on pictures for better viewing)*</em></p> <p style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjArMdDasM3Og2V_PISv5YeyWbP5uiTg4b89f-_6-uCQhB2_Gxh5s4jP6bBMBEUxByHWndJTmlDqhdefQv6ue8Xkq1Mc4s6ERYUg9bPaJz87uDAz9vYfyNIaFa788XFCulUUzbLlyrEW8vf/s1600/wealth+effect+1.JPG"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjArMdDasM3Og2V_PISv5YeyWbP5uiTg4b89f-_6-uCQhB2_Gxh5s4jP6bBMBEUxByHWndJTmlDqhdefQv6ue8Xkq1Mc4s6ERYUg9bPaJz87uDAz9vYfyNIaFa788XFCulUUzbLlyrEW8vf/s320/wealth+effect+1.JPG?__SQUARESPACE_CACHEVERSION=1302035149299" alt="" /></a></p> <p>At a first glance, it is difficult to see any meaningful correlation between the two, but look closer at the period from 2007 and onwards (as well as in 2001) and you will see a closer semblance. But this may also be a case of the infamous spurious correlation as stock prices and consumption are strongly correlated around recessions and thus also in the rebound.</p> <p style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhOa3TwrA_F90L6vgyl5Yxkm-DwUx6vejJnMGWEJmlQipojNJyho2jyszb-YoVB17MeUb3Edm697yEbjOg5bMijVz9qV6sdAnY9-l9nek5E-XxpMmYQB-pOLa2I6OOnN6s3TmKsuveZdi8r/s1600/wealth+effect+3.JPG"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhOa3TwrA_F90L6vgyl5Yxkm-DwUx6vejJnMGWEJmlQipojNJyho2jyszb-YoVB17MeUb3Edm697yEbjOg5bMijVz9qV6sdAnY9-l9nek5E-XxpMmYQB-pOLa2I6OOnN6s3TmKsuveZdi8r/s320/wealth+effect+3.JPG?__SQUARESPACE_CACHEVERSION=1302035176014" alt="" /></a></p> <p style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj4UDX40Qtua_hDPkflzLuXp3k-v5fOc3g3B7IGXrNsmGuuT2nCDfku4oT5osjb5jgdk4n3-HRGr2WagixhQGGRHSYArOZ2pxjfPscM8j55y6LW3NLajbAmDsfrk67VV8ntxFvcm2WkUxrD/s1600/wealth+effect+2.JPG"><span class="full-image-block ssNonEditable"><span><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj4UDX40Qtua_hDPkflzLuXp3k-v5fOc3g3B7IGXrNsmGuuT2nCDfku4oT5osjb5jgdk4n3-HRGr2WagixhQGGRHSYArOZ2pxjfPscM8j55y6LW3NLajbAmDsfrk67VV8ntxFvcm2WkUxrD/s320/wealth+effect+2.JPG?__SQUARESPACE_CACHEVERSION=1302035223404" alt="" /></span></span></a></p> <p>Surely, the linear fit depicted above for the full period is not statistically significant which suggests that measured over the grand sweep of time there is no meaningful correlation between changes in stock prices and changes in consumption expenditures. Importantly, this would also seem to invalidate the Fed's link between QE2 and rising stock prices since such a link is empirically dubious at best. Yet, as the graph from the period 1999 to 2010 shows the link may have strengthened.</p> <p>To that end I have conducted a small study fitting a linear model with the annual change in consumption expenditures as dependent variable to the change in the SP500 as well as government transfers and real disposable income to control for the marginal propensity to consume and the fiscal multiplier. I use monthly values to get 612 observations in the full sample regression (1960 -2010). Crucially, I split up the dataset in three periods; 1960-1980, 1981-1998, and 1999-2010.</p> <p>In the full period, the estimation gives an MPC of 0.41 [1], a multiplier from government transfer worth of 0.09 and from the SP500 equal to 0.027 (all significant at 1%). This implies that a 1% annual return in the SP500 yields an increase the annual change of consumption expenditures of 0.027%, but the results also indicate that the "fiscal multiplier" is about three times larger. So, not exactly convincing results to support QE as an attempt to boost consumption through the stock wealth effect.</p> <p>Splitting the period as noted above [2] does seem to add value to the analysis. For the period 1960-1980 the simple OLS estimate yields nothing and not even the estimate for the MPC is significant [3]. In the period from 1981 to 1998 the MPC is estimated to be 0.48, the multiplier from government transfers at 0.14 and lastly for the SP500 at 0.014 although this estimate is only significant at 10%. The period from 1981 to 1998 thus return a strong fiscal multiplier (at least in terms of significance) while a weak, at best, multiplier from the SP500.</p> <p>In the final period however, something interesting happens. The MPC increases to 0.58 which squares well with the declining saving rate in the same period. More interestlingly however, the estimate for the fiscal multiplier changes signs while remaining significant at 1%. The estimate suggests that a 1% increase in government transfers will yield a -0.36% decrease in consumption expenditures. Surely, proponents of Ricardian Equivalence would be interested in testing more thoroughly for the validity of this estimate. Meanwhile, the estimate for the wealth effect from stocks is estimated at 0.035 and significant at 1% (and thus quite close to the wealth effect estimated in the full period).</p> <p>Finally, and focusing on the period 1999-2010, I also fitted a linear model with the savings rate as dependent variable. The rationale here would be that the wealth effect from the stock market should materialise in a negative relationship and thus that a rising stock market would counteract deleveraging. Not surprisingly the coefficients for both changes in income and changes in government transfer are positive which suggests that higher income and transfers from the government leads to higher savings (that Ricardian Equivalence again?). The coefficient estimated for the SP500 is negative and much higher than the wealth effect to consumption. All estimates are significant at 1%.</p> <p><strong><br /></strong></p> <p><strong>The What, Why and Where of QE<br /></strong></p> <p>As my readers would no doubt remind I have added nothing to the debate of whether QE affects stock prices <em>in the first place</em> and then has an effect on the real economy through the wealth effect. I have taken this as given on particular notice of Bernanke's explicit comments on the success of QE2 in relation to a rising stock market.</p> <p>As it turns out, the story is a bit more complicated than that.</p> <p>Take Morgan Stanley's Gerald Minack for example who recently came out strongly against the notion of QE as a driver of risky assets which invariably leads to a much more bullish and broad based recovery discourse;</p> <blockquote> <p>I am pushing back against the view that QE – particularly the large-scale asset purchases – directly drives risk assets. The reason I am skeptical is that no one has to my satisfaction explained how – sentiment aside – QE has had a material effect on the demand for, or funding of, risk assets. It’s not even straightforward to isolate the effect of QE on the assets that the Fed purchased.</p> <p>(...)</p> <p>As I see it, QE2 was a $600bn placebo. If enough investors think it was good for risk assets, then perhaps it was good for risk assets. Stopping the placebo may have an effect, but my sense is the macro will remain the key driver of risk assets.</p> </blockquote> <p>The first part of Minack's objection to the QE-Risk Asset synthesis is important and I have also found it difficult to replicate the idea that QE directly drives risky assets . But the link need not be that specific for the end of QE to have an adverse effect of the growth narrative. I think the underlying reason as to why the market may now be driven by the improving macro picture is exactly because QE is seen as an integral part of that improvement. It then stands to reason that if and when QE ends (without extension) it will have an impact. Another point relates to the idea that the commitment itself to QE is paramount and thus that the largest effect of QE is back loaded around the announcement [4]. I think it is an accurate way to frame the effect of QE but this also implies that a second layer of expectations may take hold in the form of the expectation of the announcement. In reality, it is difficult to see how many of these "announcements" the market has discounted I think.</p> <p>An altogether more heavy analysis recently came from CSLA's Russel Napier simply noting that investors ought to sell US equities on the failure of QE2. Napier particularly makes the point that QE2 has materially failed to induce banks to increase credit.</p> <blockquote> <p>Broad money has contracted since the launch of QEII in November 2010 and this suggests that rising growth and inflation are not likely. QEII is boosting unused bank reserves, but banks continue to shrink credit and it is having no direct positive economic impact beyond depressing Treasury yields. Equity-market valuations are close to bubble levels and need the prospect of higher inflation and negative real rates to continue higher: but M3 is contracting.</p> <p>(...)</p> <p>The failure of QEII will undermine investor faith in a monetary solution. With equities near bubble valuations, based on cyclically adjusted PE, a failure to reflate risks major downside. The Fed will try again with a new package, but investors would do best by waiting to see how it plays out.</p> </blockquote> <p>This analysis then suggests a much more imminent and substantial effect of the alleged failure of QE2 and thus also the effect of a non-committal to QE3. Clearly, we are now in the situation where this illusive concept of the monetary transmission mechanism becomes important.</p> <p>Thus, has QE2 succeeded because it has helped equity prices to rally or has it been a failure because of its inability to induce more than an increase in excess reserves?</p> <p>I won't pretent to give full answer on this (Napier's analysis is difficult to disagree with) and I would like instead to yield the floor to John P. Hussman who recently had <a href="http://www.hussmanfunds.com/wmc/wmc110328.htm">a very well written and balanced column on the end of QE2</a>;</p> <blockquote> <p>My intent is not to argue strongly that the economy cannot continue to expand as fiscal and monetary stimulus comes off, but instead to at least ask why this should be expected as a foregone conclusion. On the basis of leading indices of economic activity, we observe more indications of economic slowing worldwide than we observe growth. Moreover, strong periods of employment growth have historically been preceded by high, not low, real interest rates. This is far from a perfect relationship, but it is clear that historically, high real interest rates are far more indicative of strong demand for credit, new investment, and new employment than low real interest rates are.</p> </blockquote> <p>I would file this under "I'd wish I said that". The big question then remains as to what kind of momentum the economy and risky assets will retain once stimulus comes off.</p> <p>To summarize, I have been critical of the Fed's decision to tie its policies so close to the movements of the stock market and I still am. The idea to implicitly target stock prices is the ultimate form of hubris that a central banker can commit since it plays into the notion that the central bank can consistently fine tune financial markets. It can't. However, my analysis above gives some support to the idea that QE works, and works well, through its effect on stock prices. At least, I would note that the extent to which e.g. Krugman is right the apparent change in the wealth effect over time gives some credence to Bernanke's comments in 60 minutes even if I don't agree with the Fed's strategy on this point.</p> <p>---</p> <p>* The data used for my estimations are monthly data from the St. Louis Fed's database.</p> <p>[1] - Clearly this is below traditional Keynesian estimates but remember that we have monthly data in changes and thus likely to have stationary time series (i.e. we have detrended series!).To be rigorous one would obviously have to properly test the unit root properties of the series in question.</p> <p>[2] - I am considering writing this up as a small paper trying to quantify the structural breaks in the data as well as to fit a non-linear model.</p> <p>[3] - Which points to the notion developed exactly by researchers (Friedman for one) using data for that period that consumers spend out of permanent income and not current income.</p> <p>[4] - I believe Goldman Sachs made a top notch study on this.</p> </div>CVhttp://www.blogger.com/profile/16843402165210120665noreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-45998401813938656772011-04-04T01:09:00.000-07:002011-04-04T02:05:23.513-07:00Global Manufacturing Slips Back Slightly In Marchby Edward Hugh: Barcelona<br /><br />Evidence which would enable us to assess the full economic impact of the Japanese earthquake and tsunami is still hard to come by. There is a lot of talk of supply chain disruptions, but little in the way of detailed evidence to back up assertions of the more anecdotal kind. Even the latest set of manufacturing PMI data has decidedly left the jury out on the topic.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjo6O2f9DVPJV2XRGzVJSaSSLB8dQ9wooRBn8TDVxfWKS1sW6cnLvkKmaEo2rrXjo9PkVsZuvpR7Ft1sNMdOHh_pjkATiFLUYp_XJTuzbpxWqYmj3r1freJypIRWwBmzQR6iDV3pa018Zhz/s1600/JP+Morgan+Global.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjo6O2f9DVPJV2XRGzVJSaSSLB8dQ9wooRBn8TDVxfWKS1sW6cnLvkKmaEo2rrXjo9PkVsZuvpR7Ft1sNMdOHh_pjkATiFLUYp_XJTuzbpxWqYmj3r1freJypIRWwBmzQR6iDV3pa018Zhz/s400/JP+Morgan+Global.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5591638703977896114" /></a><br />Evidently in Japan there was a clear and substantial drop in activity, but that was only to be expected . The Japanese March PMI slumped to a two-year low of 46.4, down from February’s reading of 52.9, the largest one month drop on record.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEipDfhV56Tk4Z4BOjETvTA84WMAeN4A4Q0nsl-1ZEKXSYqagnP54JosraAv7jPeV0Yb0QdctV6DUFwMS562S2GIv3VMzJRBDctyBkTmsS5yPTNo9Mpt4XR5uaACFJD7DNpJARQHHuK_r2fw/s1600/Japan.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEipDfhV56Tk4Z4BOjETvTA84WMAeN4A4Q0nsl-1ZEKXSYqagnP54JosraAv7jPeV0Yb0QdctV6DUFwMS562S2GIv3VMzJRBDctyBkTmsS5yPTNo9Mpt4XR5uaACFJD7DNpJARQHHuK_r2fw/s400/Japan.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5591638220193347458" /></a><blockquote>Commenting on the Japanese Manufacturing PMI survey data, Alex Hamilton, economist at Markit and author of the report said:<br /><br />“March PMI data provide the first indication of how output at small, medium and large sized Japanese manufacturers was affected by the events following the Tohoku earthquake on 11 March. The PMI slumped to a two-year low, suffering the largest monthly fall in points terms since the survey began in 2001, exceeding the drops seen after 9/11 and the collapse of Lehmans. The latest index reading is consistent with a decline in Japanese industrial production of around 7.0% on a 3m/3m basis".<br /><br />“Suppliers’ delivery times lengthened at a survey record pace amid widespread disruption in the supply chain resulting from the disaster. These delays could affect production in coming months and drive input price inflation even higher than the two-and-a-half year peak seen in March.”</blockquote><br />At the same time it is hard to disagree with this conclusion, presented by Nomura economist Richard Koo in a recent report on the subject:<br /><br /><blockquote>Any analysis of Japan's position vis-à-vis the rest of the world needs to start with the question of whether Japan was running a trade surplus or deficit. A trade deficit implies the world has lost a customer: ie, demand: whereas a surplus would mean the world has lost a producer, namely, a supplier of products and intermediate goods. Inasmuch as Japan boasts the world's third-largest trade surplus after China and Germany, I think the world has lost an important supplier.<br /><br /><br />Supplier countries' products are typically in demand for one of two reasons: either they are cheap or they are essential. A key to distinguishing between the two is the exchange rate. When a nation's currency is cheap relative to those of its trading partners, its exports tend to fall into the first ("cheap") category, whereas exports from countries with a fully or over-valued currency tend to fall into the second ("essential") group.<br /><br />The Japanese yen has been the strongest currency in the developed world since the Lehman-inspired financial shock. Its strength was reaffirmed when it surged into the Y76-77 range against the US dollar in the wake of the earthquake. Japan has continued to run one of the world's largest trade surpluses in spite of an extremely strong currency. Inasmuch as this is evidence that there are many businesses around the world that must buy Japanese products regardless of the cost, I suspect that many of Japan's exports cannot be easily substituted.</blockquote><br />But elsewhere, at least on the surface, there was little sign that companies were being held back by any substantial shortage of components.<br /><br />Digging a little deeper, while manufacturing output strength weakened slightly from February, survey respondents still indicated companies were raising output rapidly. On the other hand it is hard to sort the wood from the trees here, since global output could weaken for any of a number of reasons, most of them nothing whatsoever to do with Japan.<br /><br />More significantly, manufacturing activity did slow in South Korea, and failed to really recover in China following the end of the new year holiday season. These two countries are among the most closely integrated with the Japanese economy.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhgGv1uomEU_xwL8C8r_FzOWZ1qNXMfjTVM9zc6atOvn1d1VXDhda0tvFdEQVugSnkCfWgbo-N25isA_6HLHuZiU6oQ5bxBC3KvfXZ013GqoSnON2fsBSPx22milYyJRmsFVMSlHUx_hWVO/s1600/Korea.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 290px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhgGv1uomEU_xwL8C8r_FzOWZ1qNXMfjTVM9zc6atOvn1d1VXDhda0tvFdEQVugSnkCfWgbo-N25isA_6HLHuZiU6oQ5bxBC3KvfXZ013GqoSnON2fsBSPx22milYyJRmsFVMSlHUx_hWVO/s400/Korea.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5591638867472264274" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiOw8q6ttvN91xYj-FrB05dYXQLlYEVdRqG_zhASH5lbhMIuLK2oFHxe1fWURqBzMu-aa_kFnyfFhyL6LtvOhX5Pq2wbcuLr7MWAcRmGc754mKK5g1rI-zISGlkV63mFWlNpLG3XY8vZ3ub/s1600/china.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiOw8q6ttvN91xYj-FrB05dYXQLlYEVdRqG_zhASH5lbhMIuLK2oFHxe1fWURqBzMu-aa_kFnyfFhyL6LtvOhX5Pq2wbcuLr7MWAcRmGc754mKK5g1rI-zISGlkV63mFWlNpLG3XY8vZ3ub/s400/china.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5591639100233253090" /></a><br /><blockquote>Commenting on the China Manufacturing PMI survey, Hongbin Qu, Chief Economist, China & Co-Head of Asian Economic Research at HSBC said:<br /><br />“The Final March manufacturing PMI confirmed that the pace of manufacturing expansion has stabilised after slowing in February. This implies economic growth is only moderating rather than slowing too much. More importantly, price hikes also started to slow in March. All these confirm our view that quantitative tightening is working. So as long as Beijing keeps tightening for another three to four months, inflation should start to slow meaningfully in 2H2011.”</blockquote><br /><br />On the other hand, there has been plenty of earlier evidence that the Chinese economy may now be slowing somewhat, and this for its own domestic reasons. So it is hard to know what is attributable to a Japan impact here, and what isn't.<br /><br />Certainly it does seem that economies in Asia are now slowing somewhat, and since the region has been one of the main drivers of the global economy, then this slowing will be noticed in those economies which are most dependent on exports.<br /><br />Curiously, both in Europe and in China the final PMI reading was below the initial flash estimate, which could suggest that problems mounted a bit as the month advanced, with those responses which came in later being slightly less optimistic.<br /><br />Either way, the big issue isn't the supply chain disruption one - since lost output can (in general) be quickly recovered in this context, especially given the degree of surplus capacity which still exists in the global manufacturing system - rather the question is one of where exactly we are in the current global cycle?<br /><br />Many Emerging market economies have plenty of scope for continuing rapid expansion, as long as the markets are still willing to fund them. And risk sentiment doesn't seem to be an issue at the moment, although forthcoming monetary policy decisions at central banks in both the developed and the developing world make the mid term outlook rather more uncertain than it was six months ago.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvse-hLyyGtZWemUbGabyN0y0MWMZOCxLXeBmVIx9csZS3MfrkZIXiC-WZvFGxX0LYKrBISvjgUEZ5mSEu_VnpsHcClr7pWkrav41Kh-YztwJUI1OLp8GApqbibokeSWuftflqaSedXtlL/s1600/India.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 223px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvse-hLyyGtZWemUbGabyN0y0MWMZOCxLXeBmVIx9csZS3MfrkZIXiC-WZvFGxX0LYKrBISvjgUEZ5mSEu_VnpsHcClr7pWkrav41Kh-YztwJUI1OLp8GApqbibokeSWuftflqaSedXtlL/s400/India.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5591639508163595714" /></a><br /><blockquote>Commenting on the India Manufacturing PMI survey, Leif Eskesen, Chief Economist for India & ASEAN at HSBC said:<br /><br />"The momentum in India's manufacturing sector held up well in March, suggesting that growth is not an immediate concern. Output growth kept up the pace and the inflow of new orders accelerated, holding promise of a continued strong momentum in output in the months ahead. However, capacity constraints are tight as reflected in the increase in the backlog of works. Also, manufacturer's are facing ever steeper increases in input costs due to tight labour markets and rising material costs, which are increasingly being passed on to output prices. In turn, this calls for further tightening of monetary policy to tame inflation pressures."</blockquote><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5-dDPvDHRrykU2nV_otrcuROIbjmcP-o6vSE8bu8MNL1InOApGA9c3LcPUOiVyb9B49mk-qtsW-DyEHUI6jQ3AIR_x3kMlDaHZAlDBisGuvAV2ChOYOfjMVlYHJr3QKgUWoaAYrNE7xmJ/s1600/south+africa.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 236px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5-dDPvDHRrykU2nV_otrcuROIbjmcP-o6vSE8bu8MNL1InOApGA9c3LcPUOiVyb9B49mk-qtsW-DyEHUI6jQ3AIR_x3kMlDaHZAlDBisGuvAV2ChOYOfjMVlYHJr3QKgUWoaAYrNE7xmJ/s400/south+africa.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5591639443312342482" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg7jFp8QVnjMWQcAIJ4mv9kwhOIXX2qMMUDo3PF2oGtcv-PLXwGcBp_IQ9tjHYRyyUiNQ7OyHFu3ybsgOmlGY6v8vhX2mGv-LDX33aPxmhibUn7CwDVGRL_97X5iLIRoCIlP1Qt6uWsHHp4/s1600/Turkey.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 224px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg7jFp8QVnjMWQcAIJ4mv9kwhOIXX2qMMUDo3PF2oGtcv-PLXwGcBp_IQ9tjHYRyyUiNQ7OyHFu3ybsgOmlGY6v8vhX2mGv-LDX33aPxmhibUn7CwDVGRL_97X5iLIRoCIlP1Qt6uWsHHp4/s400/Turkey.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5591639377547767362" /></a><br /><blockquote>Commenting on the Turkey Manufacturing PMI survey, Dr. Murat Ulgen, Chief Economist for Turkey at HSBC said:<br /><br />“Turkish manufacturing sector performance eased somewhat in March from its record high level in the previous month, though it still remained comfortably stronger than past averages. The slight slowdown in the rate of expansion was caused by output and new orders, both of which also expanded at slightly lower, but still markedly strong rates. There was a solid slowdown in new export order growth, possibly reflective of uncertainties in the Middle East & North Africa region, while backlogs of work fell despite the weaker expansion of output. Employment conditions continued to improve as manufacturers continued to hire more workers to meet robust demand and production. There was a slight decline in stock of purchases in March due to shortages of raw materials, as reported by survey participants, that was also evident in the continued lengthening of supplier delivery times. While both input and output prices rose at slower rates than in February, they both continued to signal pipeline inflationary pressures in the manufacturing industry.”</blockquote><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjCFW_gHKUZHFwy_0Hdr1KauoQeq2eXbgoqe7ZPaaiy0UHcM69slYAyDltJonM84C_GA8J-h9CrgpEV9R6VcxEDWiITSGbSTllW0qugVBAa6OzEhczzgv2uIaev74ZMToDF4P3d2nEFDd6N/s1600/Brazil.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 225px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjCFW_gHKUZHFwy_0Hdr1KauoQeq2eXbgoqe7ZPaaiy0UHcM69slYAyDltJonM84C_GA8J-h9CrgpEV9R6VcxEDWiITSGbSTllW0qugVBAa6OzEhczzgv2uIaev74ZMToDF4P3d2nEFDd6N/s400/Brazil.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5591639315204743026" /></a><br /><br /><br />In the Eurozone,where the headline PMI slipped from 59 in February to 57.5, the results followed a now familiar pattern, with Germany, France and Italy all showing quite robust expansions, while Greece, Spain and Ireland continue to struggle, even if in each case the performance was an improvement on earlier months. Of the three, only Greece continued to show a contraction in activity, even if this was at a slower rate than previously.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXzvGXL1r9WCZzNb3oDDsOtZQQYu_UERRTc-8FxWFQzcsrgcnAmHjHL-pM66Xiq6g4v7C6SPl17yZiNrDR-jjdruLOpgocYekxfSvfDVtXgTTVph0GuGFNl1jdkCgkd3PrHiVAGsbZpIPv/s1600/eurozone+manufacturing.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXzvGXL1r9WCZzNb3oDDsOtZQQYu_UERRTc-8FxWFQzcsrgcnAmHjHL-pM66Xiq6g4v7C6SPl17yZiNrDR-jjdruLOpgocYekxfSvfDVtXgTTVph0GuGFNl1jdkCgkd3PrHiVAGsbZpIPv/s400/eurozone+manufacturing.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5591639876382256290" /></a><br /><blockquote>Chris Williamson, Chief Economist at Markit said:<br />“The Eurozone’s manufacturers continued to report buoyant business conditions in March. Despite the slight easing since February, the data are consistent with industrial production growing at a quarterly rate of 2%, spearheading the region’s recovery.<br /><br />“National divergences are marked, however, with surging output growth driving record job creation in Germany, while weak or falling production led to ongoing job losses in Spain and Greece.<br /><br />“The record jump in average prices charged for goods will further encourage the European Central Bank to increase interest rates sooner, rather than later, which may drive further divergences among member states as higher borrowing costs hit already weak demand in the periphery.”</blockquote><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQ8S7yNRic6nFCRoy-9GfkMEVjfEZyyTRJ4zPFGo1i5yW0z8I73xVQQxy87Lr_i5tGQ5fUEp6M1vBgu83vodYVE5Nfg8cINwVW4jCa0Fgx2PPRDzzYlBJsn8cr6_RdHQQKp1K2zKI63WkE/s1600/German+manufacturing.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 215px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQ8S7yNRic6nFCRoy-9GfkMEVjfEZyyTRJ4zPFGo1i5yW0z8I73xVQQxy87Lr_i5tGQ5fUEp6M1vBgu83vodYVE5Nfg8cINwVW4jCa0Fgx2PPRDzzYlBJsn8cr6_RdHQQKp1K2zKI63WkE/s400/German+manufacturing.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5591640143604113010" /></a><br /><blockquote>Commenting on the final Markit/BME Germany Manufacturing PMI survey data, Tim Moore, senior economist at Markit and author of the report said:<br /><br />“German manufacturing growth cooled during March, but the latest figures confirm an exceptionally strong performance for the sector across Q1 2011 as a whole. Firms continued to benefit from steep gains in inflows of new business during March, helped by the fastest expansion of export orders for ten months.<br /><br />“The survey’s fifteen-year anniversary was marked by a series record rise in manufacturing employment levels, as firms continued to step up production capacity in response to steep improvements in order books.<br /><br />“March data indicated higher levels of purchasing and stocks of inputs, reflecting concerns about lengthening supplier delivery times as well as greater production requirements. Strong global demand for raw materials was cited as the primary reason for supply chain delays, and only a small proportion of the survey panel cited the earthquake in Japan.<br /><br />“Surging raw material and transportation costs meanwhile meant that factory gate price inflation accelerated to a level last seen in the wake of the January 2007 VAT rise.”</blockquote><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgOFVqhcbFa2FXvd3l73fLELVMJQWPgc0Gup9SCfRgQAyhut_ugLztatl1ggXpxd-T7c9bacyQKqwnJ5jrNryQdlY7FHx8lN8_ksuQ8xvFutBQwRl2_D7DTUKtvHqUrYK16wjAKWq7EH5Ju/s1600/Spain+Manufacturing.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgOFVqhcbFa2FXvd3l73fLELVMJQWPgc0Gup9SCfRgQAyhut_ugLztatl1ggXpxd-T7c9bacyQKqwnJ5jrNryQdlY7FHx8lN8_ksuQ8xvFutBQwRl2_D7DTUKtvHqUrYK16wjAKWq7EH5Ju/s400/Spain+Manufacturing.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5591640349563388562" /></a><br /><blockquote>Commenting on the Spanish Manufacturing PMI survey data, Andrew Harker, economist at Markit and author of the report, said:<br /><br />“The latest PMI survey indicated a continuing divergence between demand in domestic and foreign markets, with the latter proving the main source of new order growth. Meanwhile, a record rise in output prices was recorded, although the rate of charge inflation remains much weaker than that seen for input costs as firms struggle to fully pass on price rises to clients.</blockquote><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgyuvjsqbJDirNl3DLm9vjYcqktxIbUb54NuY-yKwvkg8jrOXgIUMRuwfADXtw25QtdHujO838Z2RIUz3lXB9lx_tUFmVCX-v6vkhyVUgBNB1x-o8KhmOFLPQvIXNrILxhpsc4y1dhYFQuS/s1600/Greece.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgyuvjsqbJDirNl3DLm9vjYcqktxIbUb54NuY-yKwvkg8jrOXgIUMRuwfADXtw25QtdHujO838Z2RIUz3lXB9lx_tUFmVCX-v6vkhyVUgBNB1x-o8KhmOFLPQvIXNrILxhpsc4y1dhYFQuS/s400/Greece.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5591640280519869970" /></a><br /><blockquote>Phil Smith, Economist at Markit and author of the Greece Manufacturing PMI said:<br /><br />“Waning domestic and international demand for Greek manufactured goods continued to hurt the sector during March. Crucially, firms were left with little choice but to absorb sharp input price inflation and find savings elsewhere. To some extent, this came in the form of rapid stock depletion. Hope, however, might be taken from the fact that business wins by surveyed firms fell at the slowest rate for ten months.”</blockquote><br /><br />But the issue this raises is that the global economy must now be getting somewhere near the peak of this cycle, at least in terms of manufacturing activity. Central banks across the globe are moving into tightening mode, and much of the low lying fruit has now been eaten, so the issue for the fragile economies on Europe's periphery (who are now totally dependent on movements in demand elsewhere for growth) is how they will fare, not during the highpoint, but as and when the current expansion slows.<br /><br />In the US, the PMI index, compiled by the Institute for Supply Management, edged down from 61.4 in February to 61.2 in March, but stood at a level close to a 27-year high.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWRh9hJFM3jKffsvi4Oatydz0UjIa1bm3A0A2R-S-H_RdpBGdFZOcJ8G9czkv0Gd7o3A0xk-UZuOJPX1gFa2ay_gh61ZZy2-y2Ffl2ybu5-zBXCDtyhh984yWLjuO_ISL7sTwip6ifstdB/s1600/USA.png" onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWRh9hJFM3jKffsvi4Oatydz0UjIa1bm3A0A2R-S-H_RdpBGdFZOcJ8G9czkv0Gd7o3A0xk-UZuOJPX1gFa2ay_gh61ZZy2-y2Ffl2ybu5-zBXCDtyhh984yWLjuO_ISL7sTwip6ifstdB/s400/USA.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5591640755037221042" /></a><br /><br />Norbert Ore, chairman of the ISM, said “the component indexes of the PMI remain at very positive levels and signal strong sector performance in the first quarter”. Despite the positive result this month, doubts remain about where exactly we are in the cycle at this point. Danske Bank's Signe Roed-Frederiksen thinks we may be near the peak, which doesn't mean a collapse in activity, but simply that from this point the rate of expansion may slow:<br /><blockquote>US ISM manufacturing declined from 61.4 to 61.2 in March. This was marginally higher than consensus expectations of 61.0 and our estimate of 60.7. However, details of the eport suggest that the ISM will continue lower over the coming months.<br /><br />New orders dropped to 63.3 from 68.0 and although inventories declined as well, the drop was more modest. This means that the two order-inventory differentials declined further and continue to signal a downward correction in the ISM index. The ‘new orderscustomer inventory’ differential, which has proven the most reliable on short-term movements, suggests the ISM should decline to around 57. The ‘new orders-inventory’ differential suggests a more pronounced slowdown to 56. <br /><br />New export orders weakened to 56.0 from 62.5 possibly reflecting the slowdown in Asian growth while supplier deliveries increased to 63.1 from 59.4, indicating a slower pace of deliveries. Prices paid rose further to 85.0 from 82.0 reflecting the increase in commodity prices and upward pressure on input prices.<br /><br />That said, even a moderate decline from the current level would still leave the ISM index at a healthy level.</blockquote><br /><br />Globally, the headline PMI reading was 55.8, well above the historical average and the level of 50 that attempts to separate expansion from contraction, But down from the 57.4 registered in February, largely as a result of the slump in activity in Japan.<br /><br />As David Hensley, economist with JPMorgan, put it: “There was little visible sign of supply-chain disruptions in the March surveys, but this effect is likely to be more visible in Asian emerging markets in April.”<br /><br /><br />The main concern expressed by the authors in their monthly report referred to the inflationary threat coming from a rapid rise in the prices of inputs and evidence that manufacturers were passing these on. Certainly, in this sense, the report will do little to deter decision makers at the ECB from raising interest rates when they meet on Thursday.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-8108391217192116252011-03-20T04:12:00.000-07:002011-03-20T04:24:32.044-07:00Surely There Is Nothing “Funny” About What Is Going On In Japan?by Edward Hugh: Barcelona<br /><br />As Japanese officials continue to toil away in what we all hope will be a successful bid to avert a worst case scenario nuclear meltdown even while thousands of Japanese still remain missing and unaccounted for, financial market participants across the globe have been struggling with themselves to answer one and the same question: just how serious are the economic consequences of all this devastation likely to be?<br /><br />Basically, the economic issues raised by Japan's continuing agony can be broken down into a number of categories, and especially we need to think both of global and local impacts, as well as the short term, mid term and long term implications of these.<br /><br /><strong>Short-term Pain, Mid-term Gain?</strong><br /><br />The short term local consequences are evidently likely to be quite severe. Given that large parts of the country have been (and continue to be) without electricity, that factories have been flooded and part of productive capacity permanently destroyed etc, etc, GDP is bound to plummet quite substantially as output drops and takes time to recover.<br /><br />At the global level the short term consequences are hard to evaluate. That there will be dislocation to extended supply chains is obvious, the Japanese may well buy less luxury goods, while on the other hand becoming more dependent on imported energy, a development which could well affect oil prices. In terms of global demand, it is important to remember that Japan is a significant net exporter, so in theory one country exporting less should simply leave room for others to step in and fill the gap. But things aren't as simple as that, and global trade inter-linkages mean that local shocks can easily be amplified in a way that conventional economic models find hard to capture. The shock that radiated out from the US during the great depression is a classic example from history. Impacts were much greater than a cursory inspection of direct trade effects would have suggested.<br /><br />But more than anything the issue which is being raised by Japan is one of confidence, and one of how we think about risk (an issue which has been lurking in the background without being resolved since the start of the financial crisis). Problems in evaluating risk and shocks to confidence levels are hardly good for risk sentiment, and it is an increasein this sentiment which is, at the end of the day, giving momentum to the current expansion in global economic activity. And of course risk-negative phenomena are not only to be found in Japan, a fact of which this weekend's opening of military engagements in Libya is just one more painful reminder.<br /><br /><strong>Low Frequency Events Becoming More Frequent?</strong><br /><br />The whole of the last week has been characterised by a high level of uncertainty, with oil prices remaining extremely volatile and sharp movements in the value of the yen having such a negative influence on currency markets that the G7 felt itself forced to step in. So while the external economic damage seems at the present to have been contained, with one “bad luck” event after another taking place the momentum behind the current recovery is surely coming under a lot of pressure, and all prudent analysts will doubtless be busy revising downwards their growth forecasts for the second half of the year across the board.<br /><br />There are two reasons which make me think that such a move is completely warranted. In the first place we have a global system which is completely "tensed" at this point. Many problems generated by the financial crisis have been simply kicked down the road a bit, in a bid to buy the time to find the solutions. What this means is that the whole global edifice is extremely sensitive to the impact of unusual events and sudden shocks. Which means that there is a tendency to find that just when you thought things were getting better you start to discover they are actually getting worse.<br /><br />Japan has provided us with one very good example of this. Towards the end of last year the Japanese economy had been going through what is euphemistically called a "soft patch" - the economy actually contracted in the last three months of the year - but in January and February there did seem to be signs that things were getting better, and one guage of small-business sentiment (the Economy Watchers Index) <a href="http://imarketnews.com/node/27472">had even started to surge</a>.<br /><blockquote>The Economy Watchers' Survey index for current conditions in Japan rose to a seven-month high of 48.4 in February from 44.3 in January, posting the first rise in two months thanks to a recovery in weather and labor conditions, the Cabinet Office said on Tuesday. But the outlook index was unchanged in February, ending a third straight month of an improvement, leading the government to maintain its assessment of public sentiment. The government repeated that the latest survey showed that "the economy has shown signs of picking up."</blockquote><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhq9CLoFFCGS6DDUVxDtEho8YWYdS_Xqj9o7oKUqNTGt3bkgdwth59DiHgS3ZSRlsfNEBsbGkBHzKoq5MOQii94MnqOqPPwodU0PwxXo70ili2mr8vT9Gy6RH-YitsoUu_9IOLanrkkLdM/s1600/economy+watchers.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 204px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhq9CLoFFCGS6DDUVxDtEho8YWYdS_Xqj9o7oKUqNTGt3bkgdwth59DiHgS3ZSRlsfNEBsbGkBHzKoq5MOQii94MnqOqPPwodU0PwxXo70ili2mr8vT9Gy6RH-YitsoUu_9IOLanrkkLdM/s400/economy+watchers.png" alt="" id="BLOGGER_PHOTO_ID_5585824787494421714" border="0" /></a><br /><br />This much more optimistic reading, suggesting better weather was lifting confidence, was, ironically, written on Tuesday 9 March, just three days before the deadly earthquake struck. It is a stark, if somewhat tragic, illustration of just how uncertain the world we live in actually is, and of just how difficult it is to forsee certain kinds of phenomena. On another front, who at the start of 2011 would have imagined we would at this very moment be facing a UN backed military invasion into Libyan territory.<br /><br /><strong>Longer Run Impacts</strong><br /><br />Serious as the short term impacts may well be, in the longer run the shadow which will be cast by what is currently happening in Japan could well be very long indeed, in a way which few today can even contemplate (although <a href="http://www.cnbc.com/id/42165001">see this for a good first pass</a>). The justification for this assertion is not only our increased awareness of our collective vulnerability to the impact of natural disasters, there is also Japan’s pioneer status in one very new and very global phenomenon - population ageing - to think about. As we will see below, the optimistic (I would say denial) prognosis is that Japan will soon valiantly overcome this latest bout of adversity in a similar way to which they overcame the post WWII devastation. The Japanese will surely be valiant in their efforts (one only has to think of the spirit of sacrificeof those poor workers who have been asked to handle directly the reactor problem), but their ability to overcome adversity will not be comparable to that registered in an earlier epoch when they had the wind behind them rather than gusting straight into their faces.<br /><br />It is for this reason that I recently likened the earthquake and tsunami to another mindset-shaping natural disaster: the <a href="http://en.wikipedia.org/wiki/1755_Lisbon_earthquake">Great Lisbon Earthquake</a> of 1755. Both events, for their magnitude, and for the seeming arbitrariness with which they strike any given set of individuals, inevitably leave (and left) searing scars in our psyche, the latter being characterised for the way it opened up the path to what many have termed the modern era, while the latter potentially could draw it to a close.<br /><br />What I have in mind is this, the Lisbon earthquake lead to a questioning of the "natural order of things" in a way which facilitated a more rational approach to the problems in hand. But the application of this rational approach gave rise to a "second degree" natural order of things, in which (thanks to good governance, an economic hidden hand, and technical expertise) the permanence and stability of the social and economic world around us was almost totally taken for granted.<br /><br />One good example of this would be the idea of the birth of a "<a href="http://www.google.com/url?sa=t&source=web&cd=1&ved=0CBYQFjAA&url=http%3A%2F%2Fwww.usna.edu%2FUsers%2Fecon%2Frahman%2FGalor%2520Weil.pdf&rct=j&q=modern%20growth%20era%20david%20weil&ei=nMeFTfDCLImIhQfm8LTLBA&usg=AFQjCNEEYb-c3FyKN3OG5yNN_DvEt6hZ3A&cad=rja">Modern Growth Era</a>", whereby it was assumed that economies would simply grow and grow in perpetuity, driven possibly by the dynamising capacity of ongoing technical change. The curious thing about this kind of interpretation is that Robert Solow, founder of the modern neo-classical growth model, intentionally and explicitly left technology out of his model. From a general equilibrium perspective technology does not necessarily generate economy growth.<br /><br />And now we are faced with a significant number of advanced economies which may well find themselves, far from growing, actually starting to shrink at some point during the next 50 years. The reason for this, of course, is that working-age populations will be declining and ageing at the same time as the elderly dependent population (and their health and pension needs) will be rising and rising. So it seems we are now about to become aware that the Modern Growth Era was simply that, one particular era in our history as a species and as a group of social and political animals. This era is now, in some countries, starting to draw to a close, and a new one will surely open up. My conjecture is that what is happening now in Japan may well mark a tipping point in our awareness of this process in just the same way as the surge in Sovereign Debt in some countries which occured during the financial crisis marked a turning point in how we think about demography and economics, and in how we see the sustainability of health and pension systems.<br /><br />Of course, as with all issues, there are still those who remain in denial.<br /><br />But there is another dimesnion to the Japan crisis and how we see it that ties in with the Lisbon earthquake parallel, and that is our need to change mindset. Basically the issue concerns complexity, and how useful old-mindset linear models are in helping us address the kinds of issue which arise in managing highly interconnected and interlocked economic, social and technological systems.<br /><br /><strong>The Spent Fuel Rods Storage Problem</strong><br /><br />Evidently examples of inter-connectedness, and the issues this gives rise to, are legion. I have already mentioned trade linkages, and from this point of view it will be highly instructive to watch just how the shock-waves radiate-out (or don't) from their Japanese epicentre in the weeks and months ahead. The global financial crisis was also chock-full of similar examples: Lehman Brothers folded and the rate of infant mortality in Northern India shot up, to name just one. But the unfolding events in Japan give us an almost "locus classicus" version of the problem: what to do with the used fuel rods. Now using a simple and straightforward risk management model, it might even seem to be efficient to store the spent rods in the same enclosures as you put the reactor. They are, after all, easier and cheaper to keep and eye on there, and anyway, this procedure helps overcome the sensitivity of members of the general population to being un the proximity of any form of nuclear waste. But looked at from another point of view, grouping risky elements in close proximity in this way only piles risk on risk in a geometric and not a linear fashion, exposing the entire social and economic system to the impact of a positive feedback melt-down process in almost the most literal sense.<br /><br />I personally cannot help feeling that something similar is going on in relation to positive-feedback-process risk in connection with the individual units which constitute the Spanish financial system. As long as things don't go wrong, well, they don't go wrong, but if and when they do...............<br /><br />So while the initial impact will surely constitute what most traditional economists like to call a “shock”, both to the real economy and to the equity and currency markets, this shock is unlikely to knock either the global or the local economy completely off their orbits in the short run. We are not talking (barring that worst case scenario that we all have our fingers tightly crossed won’t happen) about another Lehman type event. We are talking about a major natural disaster in a country with proven response ability. Even if Japan is currently now back in recession, rebuilding will almost certainly mean the local economy bounces back quickly again in the second half of the year. The longer run effects, however, will almost certainly be much more important. On one front the impact may well be to cast a much larger and more intense spotlight on the Japanese economy itself, with increasing questions being asked about the sustainability of its current path giving the declining and ageing population issues which confront it. And on another front, the events of the last week may well end up changing our way of thinking about the world we live in, and how we manage risk and insecurity. One week ago few would have imagined it was possible for a developed country to find itself spinning-off out of control, now the previously "unthinkable" is certainly a lot more thinkable.<br /><br /><strong>At The End Of The Day Isn’t There Something "Funny" About Japan?</strong><br /><br />Japan’s economy is totally export-dependent, riddled with deflation, has central bank interest rates pegged almost permanently close to zero, while government debt seems to be on a virtually unstoppable upward path. Just to give some idea, IMF Japan projections are for GDP growth of around 1.75% a year between now and 2015. During the same period the government debt to GDP level will rise from 225.8% in 2010, to 234% in 2011 and then onwards and upwards to 249.2% in 2015 - that is the debt is rising at over 5% of GDP a year, while GDP is growing at under 2%. Personally I'm surprised that more people don't think there is something funny about these numbers, especially in the context of ongoing deflation and massive liquidity provision from the central bank.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjloADUh0buSET7SKX1cIRNRhVTSyIv6ESGfaDBvIEszCdXx5qxHTeVoS7wWOSdq996baC1JEygszEBzL6nA_QsRbH3JdnEUMS55l05PBywLigknwgRmwYdZvWR3Iqo0NwmYQgqd7CGFnI/s1600/Japan+Core+Retail+Index.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 186px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjloADUh0buSET7SKX1cIRNRhVTSyIv6ESGfaDBvIEszCdXx5qxHTeVoS7wWOSdq996baC1JEygszEBzL6nA_QsRbH3JdnEUMS55l05PBywLigknwgRmwYdZvWR3Iqo0NwmYQgqd7CGFnI/s400/Japan+Core+Retail+Index.png" alt="" id="BLOGGER_PHOTO_ID_5585853448971687426" border="0" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjb4LkP18qO9Ux_Aa6fvz_mbdOOeOjBnef2nUE8FeOlmUwG6VZ6TlplcWrE2EwtT-DNpAfdDyiTRSUsTpqmWN_HKdoXY4OHsTwWyxrp2vVjgAh3xcqCKvYq1UQl9VjEDDOBYxDfoilXfKg/s1600/japan+retail+prices.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 186px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjb4LkP18qO9Ux_Aa6fvz_mbdOOeOjBnef2nUE8FeOlmUwG6VZ6TlplcWrE2EwtT-DNpAfdDyiTRSUsTpqmWN_HKdoXY4OHsTwWyxrp2vVjgAh3xcqCKvYq1UQl9VjEDDOBYxDfoilXfKg/s400/japan+retail+prices.png" alt="" id="BLOGGER_PHOTO_ID_5585853794842393602" border="0" /></a><br /><br />According to one widely held theory, none of the above matters too much since Japan’s government debt is financed from domestic saving. On this view having near permanent deflation seems to be a massive positive, since it enables money to be printed and debt to be accumulated on a never-ending basis. The perpetual motion machine has finally been invented, and is alive and well and living in Japan. Certainly the situation has all the appearance of permanence, since it would now seem to be virtually impossible for the Bank of Japan to move into reverse gear and raise benchmark rates to what was in earlier days a "normal" level of 5% since how would the government continue to finance itself, whether the savings are domestic or external? And of course, if at some point Japan did come to depend on external funding, and interest rates were forced up to 5% or more...........<br /><br />It continues to surprise me that more people do not find the whole situation odd: gross government debt to GDP only goes up and up, across all horizons, and this is supposed to be normal and sustainable?<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJ-C0uSIVKADZCfbK6JmkqKIjDK8aWqMIusYW9v2HFwWjjdnnyQx_ORJZHpk1k_mjJHPRPnn69dgHURsFH6NxAcu9RwRkiVvuxmahCOjCgT0432gYDtu4Ws12Q6IJCgMnEVs_qhJMHj74/s1600/Japan+Government+Debt.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 247px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJ-C0uSIVKADZCfbK6JmkqKIjDK8aWqMIusYW9v2HFwWjjdnnyQx_ORJZHpk1k_mjJHPRPnn69dgHURsFH6NxAcu9RwRkiVvuxmahCOjCgT0432gYDtu4Ws12Q6IJCgMnEVs_qhJMHj74/s400/Japan+Government+Debt.png" alt="" id="BLOGGER_PHOTO_ID_5585853963488057730" border="0" /></a><br /><br />On another version of events, the gross debt argument (gross debt is used simply to be able to make a comparison with other countries, such as members of the EU, where it is gross debt that is measured and quoted) is misleading, since Japan's government also has assets (like land which was acquired during the bank restructuring of the 1990s), and it is the net debt level we should be looking at. I have two responses to this objection. In the first place, the argument fails to take into account the implicit liabilities of the Japanese pension and social security systems. Once this is done you have a number which while still being lower than the gross debt figure is consideably above the hypothetical level of net savings. In the second place, while the values of the Japan government's gross liabilities to its creditors are known and quantifiable, it is much harder to put mark-to-market numbers on the assets being held.<br /><br />But in any event it is the debt dynamic which is worrying. This is not a cyclical phenomenon, but long term structural, and it is hard to see how this dynamic can be broken at this stage. Looking at the two lines in the above chart, they are moving up almost in tandem. Net debt will hit 130% of GDP this year according to the IMF, and could well be around 155% by 2015, and that was before the earthquake. So I don't really get the point people are trying to make with this argument.<br /><br />Another issue which leaves me a bit cold is the size-of-corporate-savings one, since what people are saying is unsustainable is <strong>government debt</strong>. It is simpleton-type thinking to suggest that corporate savings could simply be handed over to the government, since this involves the private sector bailing out the public sector in a way which parallels the way the public sector is often bailing out the private sector in Europe. If things were that simple, don't the people who emphasise this detail imagine someone would have thought of it and done it already?These savings are in private hands, and any attempt simply to appropriate private savings would meet with substantial resistance, not to mention the dangers of capital flight, or larger corporates simply moving offshore.<br /><br /><strong>A Population Which Has Been Allowed To Get Too Old Too Fast?</strong><br /><br />Evidently what we have here is a clear example of something which only goes on until the day it doesn’t. The underlying problem in Japan is not lack of technical ingenuity, nor is it a shortage of credit; Japan’s fundamental problem is a demographic one. The country has a rapidly ageing population, which after many years of ultra-low fertility and rising life expectancy is now the oldest in the planet, with a median age of 45 and rising. This is the backdrop to all these weird and wonderful economic phenomena we are observing, and is the root cause of the weak domestic demand, and of the ultra-sensitivity of the economy to movements in the external trade balance.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEicr9m0Z-lyF82FHN_GrA-0lCH64hBr30eJ00FwWd8rdvYD7kPlFMl1kD2usZ1UuxnJCCfc16QHLv1vdRzTtgQRkFJBk7qK-GoCQfO_C-eoafjzlbOVcIsRsHa0S_tVL78MHsp1QOFdDO8/s1600/Japan+Median+Age.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 230px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEicr9m0Z-lyF82FHN_GrA-0lCH64hBr30eJ00FwWd8rdvYD7kPlFMl1kD2usZ1UuxnJCCfc16QHLv1vdRzTtgQRkFJBk7qK-GoCQfO_C-eoafjzlbOVcIsRsHa0S_tVL78MHsp1QOFdDO8/s400/Japan+Median+Age.png" alt="" id="BLOGGER_PHOTO_ID_5585859741950299330" border="0" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh6tVtIjGrV5zdT-1XxvkJb0QdkxR-aRDCzuwllWafQZghUfUA8zGOj0uv11THI1DYVXzf1Lx5faNRD2r9NrPGsZdETZecGfLqhCwF09Pa7UNB3BvDowl3SjOzFn_0XuKODy0DKA-L4TQA/s1600/Japan+TFR.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh6tVtIjGrV5zdT-1XxvkJb0QdkxR-aRDCzuwllWafQZghUfUA8zGOj0uv11THI1DYVXzf1Lx5faNRD2r9NrPGsZdETZecGfLqhCwF09Pa7UNB3BvDowl3SjOzFn_0XuKODy0DKA-L4TQA/s400/Japan+TFR.png" alt="" id="BLOGGER_PHOTO_ID_5585859151309926242" border="0" /></a><br /><br />So the big question people need to be asking themselves is just what happens when Japan can no longer deliver the external surplus it needs to sustain economic growth? Trend growth has been falling consistently, and overdecades, in a way which is unlikely to change and logically it will at some stage turn negative.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgwCG___NyEiNbdmZza_TJWL-p9v3zKwkJzjjfRA3UWG3saRuHmEKQtWWfyy1uD3i6MrVyhPz2IwombCsi5WedSPVgVSuaI3F0K__RPnoBgd8Rmwz-6TvTx6SrGsH1BmzkKdAagsjDh3s/s1600/gdp+four.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 197px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgwCG___NyEiNbdmZza_TJWL-p9v3zKwkJzjjfRA3UWG3saRuHmEKQtWWfyy1uD3i6MrVyhPz2IwombCsi5WedSPVgVSuaI3F0K__RPnoBgd8Rmwz-6TvTx6SrGsH1BmzkKdAagsjDh3s/s400/gdp+four.png" alt="" id="BLOGGER_PHOTO_ID_5585860415423437938" border="0" /></a><br /><br />In particular this is long term contractionary pressure is evident since Japan's workforce is shrinking and ageing. The process is, unfortunately, only compounded by the current "irradiation" problem since it will lower the ability of the country to attract immigrants (at least over the next few years), even were Japan's leaders to give this a priority, which is itself unlikely to happen.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgFZt1l3CZlSI1CcFzZOdERtGz5cppH8gWp6ApG3_VKEqp4GSxiaPjqwioErqlH-kK78Z5GDkcU_wV7zCD-H_nnybz_OFTbhQZhH9RVbx_Ol7-9rhhEflAsqR6zIhSPxG1u1aNorLldP0M/s1600/Japan+total+employment.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 202px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgFZt1l3CZlSI1CcFzZOdERtGz5cppH8gWp6ApG3_VKEqp4GSxiaPjqwioErqlH-kK78Z5GDkcU_wV7zCD-H_nnybz_OFTbhQZhH9RVbx_Ol7-9rhhEflAsqR6zIhSPxG1u1aNorLldP0M/s400/Japan+total+employment.png" alt="" id="BLOGGER_PHOTO_ID_5585861520268720770" border="0" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVvvEHqSVSbEQfbLWQ35TTehchSXODV-gzu3aMcU-dl5GYQpLtNGqFNB9DwMIU7zTL-N1RkLsMK-F0ssrOpFam1BboQYWQhUj8W2NEH_IBOdvtg6XbODghLcvGAKmHcxPJXojg8N3FlGI/s1600/economically+active+population.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 204px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVvvEHqSVSbEQfbLWQ35TTehchSXODV-gzu3aMcU-dl5GYQpLtNGqFNB9DwMIU7zTL-N1RkLsMK-F0ssrOpFam1BboQYWQhUj8W2NEH_IBOdvtg6XbODghLcvGAKmHcxPJXojg8N3FlGI/s400/economically+active+population.png" alt="" id="BLOGGER_PHOTO_ID_5585861347764328434" border="0" /></a><br /><br />As luck would have it Japan did record its first trade deficit in two years in January, and while this is currently only a passing and transient phenomenon, it does constitute some kind of warning shot for what could one day happen. In fact, the Japanese economy returned to negative growth in the last quarter of 2010, and has been struggling to find the level of exports it needs to sustain growth (even despite the strong emerging market demand) as it has been weighed down since the onset of the crisis by the continuing high value of the yen. Since it is now entirely possible that growth this quarter will also be negative, Japan is now almost certainly technically back in recession.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg7UJhBFB2L4J8kjvAsJIZPg4l5paY-xeLlT92zb8Zgis6SD_Aw2WXuettp1ynELLrj8mrXba0N6_of1Ye2u5PKiBSw-vGur77UzKCiQ3zhuUebE7wXWSScZMlPkOWwJXDXnijcjZIgL8g/s1600/Japan+Constant+Price+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 202px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg7UJhBFB2L4J8kjvAsJIZPg4l5paY-xeLlT92zb8Zgis6SD_Aw2WXuettp1ynELLrj8mrXba0N6_of1Ye2u5PKiBSw-vGur77UzKCiQ3zhuUebE7wXWSScZMlPkOWwJXDXnijcjZIgL8g/s400/Japan+Constant+Price+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5585861921119014818" border="0" /></a><br /><br />Japan’s Prime Minister Naoto Kan has already stated that Japan is now facing its worst crisis since the end of World War II, and I think it is hard to disagree with this assessment, both in the context of the current “facts on the ground” and given the major challenge the country faces on the demographic front. This is what the consensus view which holds Japan is likely to suffer a temporary economic hit and then enjoy a boost from reconstruction seems to be missing. Japan is very unlikely to have a “New Deal" like economic recovery, for the simple reason that it cannot really afford to have one due to the pressing need to get the debt dynamics better under control.<br /><br />Indeed already there is talk of raising taxes to help pay for reconstruction work, since clearly a supplementary budget which incorporates more deficit is the last thing JGB market watchers want to hear about at this moment in time. So even if some increase in government debt now looks inevitable this year, the pressure to claw it back in a near term future will be significant.<br /><br />Not least of the reasons for such caution will be the growing vigilance the country’s debt is attracting from the rating agencies. Standard & Poor’s cut their Japan rating in January, and while Moody’s have been quick to point out that the current crisis will not affect their analysis, they did change their Japan rating outlook to negative from stable at the end of February on concern that the country’s political gridlock will limit efforts to tackle the debt burden. These concerns will only be heightened in the aftermath of recent events.<br /><br /><a href="http://www.bloomberg.com/news/2011-03-12/japan-faces-another-leg-down-in-its-fiscal-health-after-quake.html">According to Marcus Noland</a>, deputy director of the Peterson Institute for International Economics in Washington what Japan is facing “is a Keynesian stimulus program that nobody can argue with”. Unfortunately, this is far from being the case, Japan is at the end and not the start of its "modern growth era" and any attempt to finance a massive reconstruction programme by issuing yet more debt is likely to provoke just what Noland discounts: a lot of argument. Funny how so many people still fail to find anything “funny” about what has been happening in Japan.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-50055567467394797452011-01-15T13:20:00.000-08:002011-01-15T13:22:23.709-08:00One Step Forward in the Euro Zone?<div class="body"> <p>By Claus Vistesen: Hull<br /></p><p>It would have been hard to believe only a few weeks ago that the euro zone could be the source of any good news let alone news to help push the market forward. Yet, with last week's successful bond auctions and <a href="http://www.ft.com/cms/s/0/8f2facbe-1d40-11e0-a163-00144feab49a.html#axzz1AwxAYvzf">the pledge of international superpowers such as Japan and China</a> to buy Euro zone debt and the ECB's sudden more hawkish tones, the obvious question is; are we out the woods yet?</p> <p>Hardly, but it was interesting to observe the almost coy manner in which the ECB slowly but surely began the move towards contemplating to think about raising interest rates. We are not there yet of course, and I still think that any hike in the ECB's refi rate are, for now, confined Weber's dreams and a very distant playbook sitting around somewhere on the lower levels in the Frankfurt tower. But let us be honest, stranger things have happened than the ECB raising rates just before the next downturn. Indeed, you might even call this a leading indicator.</p> <p>In the meantime, the patchwork which is the Euro zone rescue/bail-out/backstopping mechanism is frantically being sown together. Barclay's Capital collected the following from the market drums in terms of modifications to the hybrid (EFSF) already in place;</p> <blockquote> <p>He [commissioner Oli Rehn] indicated that various options would be discussed among European policymakers but that it was too early to comment on this in more detail. However, Rehn mentioned that one modification could be related to the rate charged on EFSF loans, with a view to reduce those. Other media reports suggest this could also include the provision of short-term credits to euro area member countries requesting support, the purchase of government bonds through the EFSF, or a change of collateral rules to boost the fund’s effective lending ceiling.</p> </blockquote> <p>A lot of things on the menu then it seems, but the most important question is really that no one has talked about yet; as <a href="http://jackhbarnes.com/2011/01/13/european-rescue-fund-needs-rescuing/">Jack Barnes points out</a>;</p> <blockquote> <p>The system has reached the stage that a bankrupt sovereign state is issuing debt to buy bonds in a vehicle that is tasked with buying debt from a bankrupt Sovereign state that is no longer able to go to market. Folks this is reaching the level of a Monty Python skit.</p> <p>This brings up a serious question not seen answered in the public yet.Who is ultimately responsible for the bonds that the rescue fund is going to be selling as AAA investments? Whose AAA balance sheet is guarantying these bonds that will be sold to investors like Japan?</p> </blockquote> <p>So, apart from the obvious issue of issuing more debt to pay off the debt used to finance the debt of bankrupt sovereigns, there is a question of what exactly it is China and Japan will be buying. I am willing to give the EU some benefit of the doubt here especially since I have long been a strong advocate of issuing Euro bonds. But then, these are not Euro bonds as such, but rather instruments used to capitalise a fund which, as Jack Barnes succinctly notes, is in dire need of a capital injection even before it has deployed a single euro of capital. Obviously, the EFSF was created as an attempt to ring fence the problem in the periphery and thus to hedge against a future blow-up . But this always missed the point in the sense that we didn't really need a bailout fund, but a rather a structural change in the way we perceive and organize the link between fiscal and monetary policy in the euro zone. As traders like to remind newcomers to the business, hedges are things you buy at a B&Q, not at your broker.</p> <p>The EFSF could conceivably bailout a large part of the inflicted economies, but then there was always going to be Spain not to speak of Italy which it cannot deal with. On that note, it was eye-wateringly embarrassing to hear both the Spanish finance minister and the Portguese prime minister daftly using their respective "successful" bond auctions to note that neither of the their respective economies were going to need any form of bailout simply because <em>they don't need it!</em></p> <p>This is then not to play down what was a long awaited successful event in the context of the European debt crisis which I unilaterally applaud (and hope for more to come) it is merely my attempt to put things a little into perspective. In this light, the gradually more hawkish tone by the ECB could be be seen as a little bit of stick to show economies that while we are here to help, we are also here to do our job which is to protect the purchasing power of all the euro zone citizenry. This may of course be waffle, but the ECB has long had a legitimate problem with simply playing the game in the form of providing liquidity and and even buying up peripheral bonds while playing into inability and flatfootedness of euro zone policy makers. Naturally, my bet is that we have only seen the nascent moves of what will become a full fledged measure of QE by the ECB and much more aggressive buying of sovereign bonds (simply because they have to), but this does not mean that policy makers can simply ignore the facts as they are presented by economic data and common sense.</p> <p>But I might just be too harsh here and all it might be me who are behind the curve as those very same policy makers are <a href="http://ftalphaville.ft.com/blog/2011/01/12/455671/bail-out-portugese-and-spanish-banks-together/">now moving ahead of the curve</a> in the form of, allegedly, a two-front attack on the situation with a bail-out of Portugal and a full euro zone backstop to whatever black hole the Spanish banking sector might turn out to be. Especially this last bit is interesting because it coincides with the news (albeit not fully confirmed and digested by the analysts) that <a href="http://ftalphaville.ft.com/blog/2011/01/14/459426/an-e80bn-mega-inyeccion-for-spanish-banks/">Spain would stand ready to inject a hefty sum of money</a> to shore up its banking system.</p> <p>Here is Tracy Alloway from the FT Alphaville;</p> <blockquote> <p>Just as the European Central Bank announced that Spanish bank borrowing resumed its upward trajectory last month (€70bn in December, up from €64.5bn in November) <a href="http://www.cotizalia.com/en-exclusiva/zapatero-inyeccion-cajas-saneamiento-20110113-63696.html"><em>El Confidencial</em> is reporting</a> that Spain is preparing a massive capital injection of between €30 and €80bn to clean up the cajas, or local savings banks.</p> </blockquote> <p>Having long been the twenty thousand pound elephant in the china shop this is indeed something worth noting more than in passing. Going into perma bear mode I am thinking about Ireland and the sudden reversal of a relatively good sovereign who was brought to its knees by its promise to see through the bailout of its financial sector. The point is that Spain is structurally similar with high private debt, and relatively low sovereign debt and while Ireland was probably going to hit the canvas in any case, its situation got worse by the ongoing quibble about what euro zone bailout funds could be used for. Specifically, the explicit refusal to allow the funds to bail out banks put the whole Irish situation in a tight spot although it was eventually an academic demarcation as the two got fused through the dreaded Irish government guarantee to backstop its largest banks. </p> <p>So, I am carefully assuming that whatever Spain is brewing on here they have the potential firepower of the euro zone in the back. I have passed on this notion to a friend of mine much closer to the Spanish situation (guess who!) and here are the main points;</p> <blockquote> <p>1) This is only the cajas, there will then need to be more for the banks (somehow). In fact, once the political argument is settled, the thing is much easier in the cajas case, since because they can't go to the market with shares, the only thing to do is semi nationalise them, and then refloat later. </p> <p>2) This then will be the first de facto step of Spain into the arms of the EFSF, since obviously the Spanish sovereign won't be able to fund the injection (at least not at viable interest rates). Spain should be in completely between May and August.</p> </blockquote> <p>As such, if it is part of a general euro zone backstop to the Spanish financial system it may be quite a move (and also as noted a sea change since all the quibble on Ireland concerning the use of bailouts would be presumably have been put in the past). I emphasize this since the clock is ticking and the same momumental structural challenges lie ahead even if one country's successful bond auction may seem to have changed the situation for a while.</p> <p>As such it might be worth having a look at those fundamentals of the euro zone again and what the proposed (and inevitable) correction mechanism presents in terms of challenges.</p> <p> </p> <p><strong><br /></strong></p><p><strong><br /></strong></p><p><strong>Remember the Catch 22</strong></p> <p>Structurally then we are still faced with the same seemingly irreconcilable issues in the form of imposing internal devaluations, fiscal austerity and returning to economic growth all at the same time from within a currency union. I have called this the catch 22 of euro zone imbalances not least in relation to the idea of a debt snowball;</p> <blockquote> <p>[...] the forces which have lead to the build-up of imbalances are joined at the hip with the same forces which make it almost impossible to correct from within the Euro zone. Specifically the idea of a debt snowball effect is a good way to show why it will be almost impossible for some economies to correct their external imbalances without an explosive evolution in government debt and since they need to correct external competitiveness issues in order to achieve economic growth, the whole thing turns into a vice and essentially a catch 22.</p> </blockquote> <p>It is consequently, the rapid deterioration in the private and public debt dyanmics which euro zone policy makers and the IMF are so concerned with and thus trying hard to backstop and reverse. But it might not be so easy as to focus entirely austerity since debt dynamics are also driven by your ability to grow.</p> <p>At this point you may rightfully wonder then what the hell a debt snowball looks like? Well, why don't I show you then (see <a href="http://clausvistesen.squarespace.com/papers-and-publications/2010/5/1/quantifying-and-correcting-eurozone-imbalances-fighting-the.html">this paper </a>for the model).</p> <p>Now, in any economic model we need assumptions and instead of feeding in any of the forecasts for the periphery (which are hugely uncertain) let me take the point of view in a model economy with somewhat better fundamentals than many of the peripheral economies. As you shall see, the initial condition matters less than the underlying dynamics for creating a debt snowball.</p> <p>As such, I assume that my model economy starts with a debt/gdp at a humble 60% to GDP (say in 2010) and that it pays 5% on its <em>entire</em> sovereign debt portfolio. The point here is that while e.g Portugal might have paid 6.7% on its last issuance it does not pay this on its entire portfolio of liabilities. This is also why we have been talking so much as about roll over schedule since if you are so unfortunate that you need to roll over and refinance in times of trouble you are likely to incur a high cost that affects your entire liability side.</p> <p>Finally, I crucially assume <strong>that you can't have both austerity and growth at the same time.</strong> If you want growth it will cost a higher fiscal deficit and if you to run down the fiscal deficit you must endure deflation (negative nominal GDP growth in essence) and it is this latter which the ECB and EU are pushing. Especially this last assumption is absolutely crucial to understand since it is this situation the periphery faces with an internal devaluation in the euro zone (click on all pictures for better viewing).</p> <p style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVlyZieuZpDVCdl8wh2SFyJiAoUEMoYFbZuFVXPGiXS9oWyujTf0CC1BUxa7-Bv8e2Y3m60_1lRJ7LVJ4n7zDsSpBpcaDeqWEaOVVwBdiRvTNBDYHgTkASmiOMVVEztA45-fXF_29vLNZf/s1600/debt+gdp+simul+1.JPG"><span class="full-image-block ssNonEditable"><span><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVlyZieuZpDVCdl8wh2SFyJiAoUEMoYFbZuFVXPGiXS9oWyujTf0CC1BUxa7-Bv8e2Y3m60_1lRJ7LVJ4n7zDsSpBpcaDeqWEaOVVwBdiRvTNBDYHgTkASmiOMVVEztA45-fXF_29vLNZf/s320/debt+gdp+simul+1.JPG?__SQUARESPACE_CACHEVERSION=1295115590030" alt="" /></span></span></a></p> <p>The bar shows the average from the simulations shown by the line plots. As you can see the numbers are obviously fantasy numbers, but since this an average across many different scenarios where both the fiscal decifit (austerity measures) and growth are dynamic it might not be entirely irrelevant. The set up of these simulations are quite simple. I can change three things in my model; the growth rate, the interest rate, and the budget deficit (primary deficit) [1]. In all the simulations the interest rate is set at 5% and then I build a cross section where I dynamically change the growth rate and budget deficit building in the trade off that you cannot have a low budget deficit and "high growth" at the same time.</p> <p>Obviously, the results are quite sensitive with respect to how strong you believe the trade-off is between growth and fiscal austerity. I have built in a pretty strong trade off in order to demonstrate what I believe are signficantly worse <em>short term growth dynamics</em> than the consensus. This is also why the model's result becomes exponential at longer time horizons.</p> <p>Consider then the debt/GDP dynamics of our model economy in the first 10 years;</p> <p><span class="full-image-block ssNonEditable"><span> </span></span></p> <p style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjR2UK0lPmzWK5QtmprO2ABh78JrM8Zlzx8cBpxvZq7-UHo83I3AIK8ayjUSbm-vVX9TfBb6kZs0Awf7WC_ePRkGp4FWvW2-CuSJ7C0A38nwVcaOXgj5hPS_Wd7r9v8Bsg-qaiANgD6eglS/s1600/debt+gdp+simul+2.JPG"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjR2UK0lPmzWK5QtmprO2ABh78JrM8Zlzx8cBpxvZq7-UHo83I3AIK8ayjUSbm-vVX9TfBb6kZs0Awf7WC_ePRkGp4FWvW2-CuSJ7C0A38nwVcaOXgj5hPS_Wd7r9v8Bsg-qaiANgD6eglS/s320/debt+gdp+simul+2.JPG?__SQUARESPACE_CACHEVERSION=1295115414917" alt="" /></a></p> <p>Suddenly, the numbers look more realistic but not less scary since you need to remember that this is the average evolution of public debt across all policy mixes (i.e. in a continuum from high growth negative and large budget deficit and low negative growth and fiscal surplus). It is exactly because correcting from within the euro zone imposes this trade off that you end up in a catch 22. Take the example that our model economy manages to realize a constant budget deficit of 6% of GDP which results in a zero growth rate of GDP. In that situation the model predicts a debt/gdp ratio of 160% in 2020 (98% in 2015). It goes without saying that if your initial level of debt is higher, the corresponding level of debt will be corrected up.</p> <p>I am not presenting this as truisms and prediction tools since evidently economic models are anything but. Instead, they should serve mainly as evidence that bailouts are going to be needed and also sadly that defaults of both the sovereign and private ones are coming and they <em>will</em> be costly.</p> <p>Finally and just for the sake of argument I thought that I would demonstrate that this model is not simply about exponentially increasing debt/gdp ratios. Consequently, the "good economy" and "bad economy" below both pay 5% on interest on their government bond portfolio but the former has a budget surplus of 3% a year and grows at a rate of 3% a year as well. The latter on the other hand looks more like the periphery with a budget deficit of 5% and a negative growth rate of 1%.</p> <p style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgcaK-D3ULTeG1hd3zKGwjeDfv2cjRvMsGz9lD4MKCcY1yqUQiNSGgGmpOofbD9umy14g56Z4VL3SMJPU3Nwh6EkEyBmBGqYcVWT57gp4oRzFWQf05eeSkKLmML9xC61OEfLSj6lZ6UZS6e/s1600/debt+gdp+simul+3.JPG"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgcaK-D3ULTeG1hd3zKGwjeDfv2cjRvMsGz9lD4MKCcY1yqUQiNSGgGmpOofbD9umy14g56Z4VL3SMJPU3Nwh6EkEyBmBGqYcVWT57gp4oRzFWQf05eeSkKLmML9xC61OEfLSj6lZ6UZS6e/s320/debt+gdp+simul+3.JPG?__SQUARESPACE_CACHEVERSION=1295115474683" alt="" /></a></p> <p>Again, the point is not to extrapolate into the infinite unknown, but to observe that even in the very short run this creates unsustainable debt dynamicsfor the "bad economy".</p> <p>---</p> <p>[1] - So I am being very nice here not even considering interest rate payments on existing debt.</p> </div>CVhttp://www.blogger.com/profile/16843402165210120665noreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-9359502015028498292011-01-13T05:10:00.000-08:002011-01-13T05:22:45.511-08:00And Then There Were Seventeen....by Edward Hugh: Barcelona<br /><br />"If you know your Thucydides and the Melian dialogue you know that small countries rely most on everyone following the rules. That's why we follow the rules. If there are no rules, then the big will do what they want,"<br /><br />Estonian President Toomas Ilves in an interview with the EUobserver<br /><br /> <br />In a blog post which has gathered a certain notoriety, <a href="http://krugman.blogs.nytimes.com/2010/12/31/congratulations-to-estonia-or-maybe-condolences/">Paul Krugman recently sent the Estonians his condolences</a>. I will send them, not my condolences, but my congratulations, and these not for the somewhat dubious honour of being allowed to join the Eurozone, or even for having carried out a highly successful "internal devaluation" (this outcome is still in doubt), but rather for their stubborness, courage and tenacity. These are indeed hard (and enduring) men and women. And in honour of their courage I offer them a homage, in the form of two charts. The first of these is the latest Estonian industrial production one.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiY3c3KXn2I8dIIYw8v14KTP95OmeXty9rEfru7ZgzsTyM-Y7baO6RXgU7wwl1yFh1sjZkXvj1CLKYyfCnNvtb0D5F67KqkrRnUsvnzk0aYy4fwF1qCUUBsE3572c3DGSMUSnXetUh4HI2A/s1600/Estonia+IP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 215px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiY3c3KXn2I8dIIYw8v14KTP95OmeXty9rEfru7ZgzsTyM-Y7baO6RXgU7wwl1yFh1sjZkXvj1CLKYyfCnNvtb0D5F67KqkrRnUsvnzk0aYy4fwF1qCUUBsE3572c3DGSMUSnXetUh4HI2A/s400/Estonia+IP.png" alt="" id="BLOGGER_PHOTO_ID_5560287021364261122" border="0" /></a><br /><br />While the second is the Spanish equivalent.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgVBaGrlMdw8-FGwIVhJYHU5zKvgIDzguUrPVLz18SfFgijldWCAMgpK6ztkjGg13z-kDcExMrER9e1uKFpYGm0kRN_vQGPFKqaTcJDZwuJ7ItLuAJ2ZayiPQoyhEaAmD-OJOWKnnUjCGRn/s1600/industrial+output+-+Spanish.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 210px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgVBaGrlMdw8-FGwIVhJYHU5zKvgIDzguUrPVLz18SfFgijldWCAMgpK6ztkjGg13z-kDcExMrER9e1uKFpYGm0kRN_vQGPFKqaTcJDZwuJ7ItLuAJ2ZayiPQoyhEaAmD-OJOWKnnUjCGRn/s400/industrial+output+-+Spanish.png" alt="" id="BLOGGER_PHOTO_ID_5560287283650891650" border="0" /></a><br /><br /> <br /><br />Can you spot the difference? If not squint a little closer. Estonia's economy fell by around 18% during the crisis, while Spain's has so far has fallen only by something like 7%, yet Estonia's industrial output is now almost back to where it was before the crisis started, while Spain's has fallen but so far not recovered. No sign of even the tiniest green shoot.<br /><br /> <br /><br />Curiously, Spain's political leaders constantly complain that the markets are being unfair to their country, and are underestimating their ability and determination in responding to the crisis, yet if we compare the relative performances of the industrial sectors in the two countries, it is pretty obvious why the markets entertain the doubts they do. Both are destined now to live from exports, but one country is evidently living rather better from them than the other. It is clear that companies in the Estonian industrial sector have been far more agile in diversifing and finding new markets than have their Spanish counterparts.<br /><br /> <br /><br />Both countries experienced a construction lead "boom-bust" (Spain's of rather larger proportions than the Estonian one), and consequently now face highly impaired domestic demand, yet the Estonians have succeeded where the Spaniards have failed, by shifting a part of their previously inwardlooking industrial base towards the outside world and towards growth. There is simply no other explanation for the evident discrepancy, since (as we will see below) Estonia's industry is not growing due to the pull of domestic demand, although it is on the point of returning to "back to normal" operating levels. Spain's export sector is also recovering (after all the external demand is now there), but the part of Spain's industry which is geared towards supplying domestic demand simply hasn't been able to adapt, and is still contracting along with domestic consumption. In fact it is still contracting so rapidly that that the shrinkage is totally cancelling out all the fine work being done by the companies who are doing all the exporting, which is why industrial output remains more or less stationary, and the Spanish economy fails to return to life.<br /><br /> <br /><br /><b>Many Rivers Left To Cross</b><br /><br /> <br /><br />Well that, as they say, was the good news. What follows possibly won't be anything like so palatable for Estonians to read as what went before, which doesn't mean it isn't worth reading and thinking about. You see, that old black magic (sorry, devaluation) debate, was never about whether or not the Estonian export sector could recover to its old level after the economic contraction came to a halt. As I keep stressing, it is obvious that it could, since in this case recovery depends on factors external to Estonia, and these factors have now changed, as a number of countries have seriously started to recover. No, the issue was always about the fact that the Estonian economy had become severely distorted during the boom years, and that the existing export sector was too small to do the heavy lifting that was going to be required of it after the bust in domestic demand. How many times did people say to me during those early days "but what can we export?", or "don't you realise that Estonian exports are largely re-exports of processed imported goods", as if these added disadvantages made the situation any easier, or my arguments somehow irrelevant. When a country is in trouble, but really in trouble, one of the first signs, I reckon, of the depth of the problem is that you get a long queue of official economists lining up to give you a thousand and one reasons why it is going to be impossible to export your way out of difficulty. This is like a leading indicator for "problems looming", since the situation has become so serious that effective solutions are virtually beyond the realm of the thinkable, and we need to soothe ourselves with nice sounding palliatives. In the realm of economic science, however, reality has a nasty habit of coming back and waking us from our slumbers.<br /><br /> <br /><br />What all this really suggests to me is that the thrust of the original argument about why the size of the export sector needs to increase sharply in economnies which have become so badly distorted as the Estonian and Spanish ones have was never really properly understood. So it is in honour of all those valiant Estonians who have sacrificed so much in order to gain so little that I endeavor just one more time to make things clear (my original pieces on Estonia's internal devaluation can be found <a href="http://www.bloomberg.com/news/2011-01-12/portugal-borrowing-costs-fall-at-auction-as-bailout-speculation-diminishes.html">here</a> and <a href="http://balticeconomy.blogspot.com/2009/03/devaluation-euro-membership-and-loan.html">here</a>).<br /><br /> <br /><br /><b>The Estonian Economy Is Recovering!</b><br /><br /> <br /><br />As one-commentator-after-another never tires of informing us, the Estonian economy has returned to some sort of growth recently, indeed (hat tip <a href="http://krugman.blogs.nytimes.com/2011/01/06/what-if-they-had-a-depression-and-nobody-noticed/">to Krugman</a>) the Washington Post even went so far as <a href="http://www.balticbusinessnews.com/article/2010/12/27/The-Economist-Estonia-to-become-a-Nordic-kitten-on-Jan-1">to lump it together with Germany as one of Europe's “growing economies”</a>, while the Economist Central Europe correspondent <a href="http://www.balticbusinessnews.com/article/2010/12/27/The-Economist-Estonia-to-become-a-Nordic-kitten-on-Jan-1">described it as a Nordic Kitten</a>, seemingly a designation created to distance it from its more problematic Baltic neighbours. Unfortunately, wine doesn't improve simply by changing the label on the bottle (even if it does now say “appellation Frankfurt controlé”), and Estonia is neither a growth economy (which is the Goldman Sachs term for the new Emerging Market tigers like India, Indonesia, Turkey and Brazil) nor is it a "growing one", it is simply a "steadily recovering" one, and what's more, given the severity of the challenges it still faces it is far from having entirely managed to distance itself from the set of economic problems characteristic of what has come to be known as the “Baltic syndrome”.<br /><br /> <br /><br />Yes, Estonia’s economy has now started to grow again, indeed it was up by an annual 5% in the third quarter. But, to put this number in context, it was still down by around 16% from the Q4 2007 high, and just below the level of Q3 2005. So there is still rather a long way to go to get back to meaningful growth, indeed so long, as Krugman again points out, that IMF forecasts don't contemplate the country's economy reaching its 2007 level again before 2015 (Germany just more-or-less hit its 2007 level in 2010).<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj65-rDQCgeEapy4pXapYK4n7XSE2e5n3pndRcwFywqBmOd5ymvU7lXg3Sz0-yvACtpS-8YNRPHA8TvsBlhCmj1wWMalJHjX3lsJmXJnWC4owY2EDuj_vnBJ5E1z5kpu6y_b2hUN9JN_Dla/s1600/Estonia+Constant+Price+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 243px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj65-rDQCgeEapy4pXapYK4n7XSE2e5n3pndRcwFywqBmOd5ymvU7lXg3Sz0-yvACtpS-8YNRPHA8TvsBlhCmj1wWMalJHjX3lsJmXJnWC4owY2EDuj_vnBJ5E1z5kpu6y_b2hUN9JN_Dla/s400/Estonia+Constant+Price+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5561345738106723250" border="0" /></a><br /><br /> <br /><br />So, what is slowing the recovery down? Well, as I indicated at the start of this post, it certainly isn't the industries in the country's export sector, which are now more or less back to where they were before the crisis started.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjoEbZ_B07FSGrrvgh5KhpsaJHzrXmxxRjayLgRH28F2QOec0yLm4QN6F2XS9lu2ZAzvqRImh06iM19oCFyJ_ARru9GCYKQ8PKdbyt7ojEQVzpTSf8tyq-JhgDM0BYXNCkczsYYfjcrxyw4/s1600/Estonia+Constant+Price+Exports.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 243px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjoEbZ_B07FSGrrvgh5KhpsaJHzrXmxxRjayLgRH28F2QOec0yLm4QN6F2XS9lu2ZAzvqRImh06iM19oCFyJ_ARru9GCYKQ8PKdbyt7ojEQVzpTSf8tyq-JhgDM0BYXNCkczsYYfjcrxyw4/s400/Estonia+Constant+Price+Exports.png" alt="" id="BLOGGER_PHOTO_ID_5561351180051622146" border="0" /></a><br /><br /> <br /><br />But rather the problem lies in the state of private domestic demand, which obviously isn’t recovering.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgl7ZhhSiK-JGmgmiQ6XhMpfw0yuQ1Y2jMRv1IJGKOsQybLJSfURzVxRZyB9zOSPcVZtYL6iqdKFTIckzlmMOgfvWaqpZ9YQ04Vg4NaPc5ZS52pPsLq7AQvdOoIIfK6uiaUvFvac1kKO8dd/s1600/Estonia+Constant+Price+Private+Household+Consumption.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 244px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgl7ZhhSiK-JGmgmiQ6XhMpfw0yuQ1Y2jMRv1IJGKOsQybLJSfURzVxRZyB9zOSPcVZtYL6iqdKFTIckzlmMOgfvWaqpZ9YQ04Vg4NaPc5ZS52pPsLq7AQvdOoIIfK6uiaUvFvac1kKO8dd/s400/Estonia+Constant+Price+Private+Household+Consumption.png" alt="" id="BLOGGER_PHOTO_ID_5561352056942776290" border="0" /></a><br /><br /> <br /><br /> <br /><br />As the Estonian Central Bank put it <a href="http://www.eestipank.info/pub/en/press/Press/kommentaarid/_258.html?ok=1">in their economicpolicy statements</a> (and <a href="http://www.eestipank.info/pub/en/press/Press/pressiteated/pt2010/_12/pt1209">here</a>, and <a href="http://www.eestipank.info/pub/en/press/Press/pressiteated/pt2010/_11/pt1111">here</a>) on the latest GDP numbers:<br /><br /><blockquote>“Estonia's recovery has been mostly driven by exports, which, measured in current prices, reached close to the all-time high in September”, and “Export growth indicates that the economic activity of our main export partners is expanding quickly and Estonia's companies are making good use of it.... The export volume of industrial production reached a historical high in the third quarter. Irrespective of the continuously weak domestic demand, the sale of industrial production started to pick up in the domestic market as well, but it is still some 25% below the pre-crisis level.... since unemployment continues to be high, the level of consumers' income and purchasing power will remain weak in the next years”. </blockquote>And as the central bank also point out, export growth will now be harder (that is we <span style="font-weight: bold;">have now picked most of the low lying fruit</span>).<br /><br /><blockquote>“Though most of industrial enterprises still have under-utilised production capacity, the existing capacity stock is running out along with rapidly expanding sales volumes. This refers to the need for additional investment”.</blockquote>Yet, unfortunately, the sad truth is that investment activity has still not picked up.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDWhdeItZ75bj00k7xiOgnTGBryhc6el2VJfcndpuR6SAd44NS6oukvsLKwzEoM7jwnmomXSSip10GN14JRoytitt3ysoMK-up9vmZbcT09lgDeB3Tt9762hGPdWEdpN4FexrP4QdoXRWZ/s1600/Estonia+Constant+Price+GFCF.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 244px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDWhdeItZ75bj00k7xiOgnTGBryhc6el2VJfcndpuR6SAd44NS6oukvsLKwzEoM7jwnmomXSSip10GN14JRoytitt3ysoMK-up9vmZbcT09lgDeB3Tt9762hGPdWEdpN4FexrP4QdoXRWZ/s400/Estonia+Constant+Price+GFCF.png" alt="" id="BLOGGER_PHOTO_ID_5561351592485596754" border="0" /></a><br /><br /> <br /><br />This lack of series investment in fixed capital contrasts sharply with recent movements on the equities side, since, according to Bloomberg data, Estonian stocks are valued at an average of 16 times estimated earnings, compared with 11.3 times for Polish and Czech shares, and 12.6 times for Slovenia (the chart sort of resembles the export one, doesn't it?).<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgULmYOV2CwaKHDQevkqYPi9BCCEKN8sLICXK_GgxNQxBmKmPqhSUaFgPzwlPiZZTlv-O-oSw6Jap_3DkLy__TllIWQfP4zcoRFWKxnJsrkq2oY2e2uWe2_HwR2D7PxE_aYLnPLooLNtMww/s1600/Estonia+OMX+Tallinin+Index.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 293px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgULmYOV2CwaKHDQevkqYPi9BCCEKN8sLICXK_GgxNQxBmKmPqhSUaFgPzwlPiZZTlv-O-oSw6Jap_3DkLy__TllIWQfP4zcoRFWKxnJsrkq2oY2e2uWe2_HwR2D7PxE_aYLnPLooLNtMww/s400/Estonia+OMX+Tallinin+Index.png" alt="" id="BLOGGER_PHOTO_ID_5561355321788062450" border="0" /></a><br /><br /> <br /><br />But the issue is this: following a pattern seen in many emerging markets over the last 12 months, short-term fund inflows pushed values on the Tallinn exchange up by some 73% in 2010, making it the third-best performance worldwide, according to Bloomberg data. They also quote Tallinn-based SEB researcher Peeter Koppel as saying: “Euro adoption has somehow triggered more widespread thinking about saving and investing in general,”...... Foreign retail investors “now have the hard fact of euro and the certain caution, especially from the Scandinavian side, is gone.” Which sounds to me more like “previously wary investors have now thrown caution to the wind,” on the back of all the pro-Euro Nordic-kitten hype. What Estonia needs, and is not getting (as the central bank itself recognises) is serious, long term, FDI for greenfield projects generating jobs and output in the export sector.<br /><br /> <br /><br /><b>Boosting Domestic Demand Means Increasing The Size of the Export Sector & Creating Employment</b><br /><br /> <br /><br />As I say, in contrast to what is happening in the external sector domestic demand is far from recovering. Retail sales were up 5% (at constant prices) in November over November 2009, and 1% in October. But the annual rise is more a by-product of the very low level of sales hit in November last year, and in fact between January and November 2010, retail sales were down 4% compared to the same period in 2009.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXhPiJU1ioWj5nCIsYVZ17dUZYaxnByvDt5CdOuO-YxTlAy6Cal_rDGKlYf9rb5C1pxlfN4dhPNHQgLMqTeh9BXgFarMbX6Dpg6g3Np17QSGVQA4dX5Cqz8DoFi25avf5JrajUdUZCzHUt/s1600/Estonia+retail+sales.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 231px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXhPiJU1ioWj5nCIsYVZ17dUZYaxnByvDt5CdOuO-YxTlAy6Cal_rDGKlYf9rb5C1pxlfN4dhPNHQgLMqTeh9BXgFarMbX6Dpg6g3Np17QSGVQA4dX5Cqz8DoFi25avf5JrajUdUZCzHUt/s400/Estonia+retail+sales.png" alt="" id="BLOGGER_PHOTO_ID_5561355771731279314" border="0" /></a><br /><br /> <br /><br />The domestic construction sector isn’t recovering either. According to Statistics Estonia, the total production of Estonian construction enterprises increased 1.2% in Q3 2010 compared with a year earlier. But when you read the fine print, the increase was entirely produced by construction companies operating abroad (whose activity was up by 25%) – ie once more it is a question of exports.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdcWBXkFj8V7NZMFk2IEIAAPDcvGoaqm5nSDkGcgUhNaY5Gk_rOlFpXiMPmBgBymLSkwz5C45yQX9dbYMVyX6ar16Harec0_gINi1VZjx5iaeD6Kg8PzrvY-i0DNO4Ogje-rItqwCw2J8f/s1600/Estonia+Constant+Price+Construction.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 243px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdcWBXkFj8V7NZMFk2IEIAAPDcvGoaqm5nSDkGcgUhNaY5Gk_rOlFpXiMPmBgBymLSkwz5C45yQX9dbYMVyX6ar16Harec0_gINi1VZjx5iaeD6Kg8PzrvY-i0DNO4Ogje-rItqwCw2J8f/s400/Estonia+Constant+Price+Construction.png" alt="" id="BLOGGER_PHOTO_ID_5561355976586624258" border="0" /></a><br /><br /> <br /><br />And in fact construction output inside Estonia fell by around 1% compared to the 3rd quarter of 2009, and even this drop only wasn’t larger due to the availability of EU infrastructure funding, since the volume of building construction decreased 9% while the volume of civil engineering increased 15% at constant prices. According to data from the Estonian Register of Construction Works, in the 3rd quarter of 2010 there were only 481 housing units completed - 50% down on the same period of 2009. 65% of these were flats, the majority majority of them in Tallinn.<br /><br /> <br /><br />As the Central Bank point out, domestic demand can only improve in a sustained way if there is a major improvement in the labour market, but as they also stress, this is only recovering slowly, with the unemployment rate declining to 15.5% in the third quarter, and with the need to improve productivity and only low growth expected in the quarters to come, unemployment is likely to remain high for several years.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnoUbJ9XmyHU9pVUtB6GWI03p1x9KvfPzH-QjUO6uaeT03_pj97MmYNGDSof5u6bgMT56TQZ4PhJUl2S7KXfZkHFw6W6BaJrlx50yYQsdPIV1M1Nmc_bmVQ87Q-RK63Ns0ulxYaGPZgFsk/s1600/Estonia+Eurostat+Unemployment.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnoUbJ9XmyHU9pVUtB6GWI03p1x9KvfPzH-QjUO6uaeT03_pj97MmYNGDSof5u6bgMT56TQZ4PhJUl2S7KXfZkHFw6W6BaJrlx50yYQsdPIV1M1Nmc_bmVQ87Q-RK63Ns0ulxYaGPZgFsk/s400/Estonia+Eurostat+Unemployment.png" alt="" id="BLOGGER_PHOTO_ID_5561356284187329538" border="0" /></a><br /><br />So despite the recovery in external demand, as was to be expected the demand for domestic credit far from recovering continues to contract, whether we are talking about corporates:<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgrtQxEWbunZN05-Szqb-W3cNB5J5j3-ofaWAPLensj3Sd2fD4fMiU9Hc2AFbNuayl0HF2mqC9mE8UqKNszvaoYoyKrbHsedOFAyLeTOW0OIjaG685AOk408gLQscjgrvrYj_3gkTF8L8Vm/s1600/Estonia+Corporate+Borrowing+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 204px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgrtQxEWbunZN05-Szqb-W3cNB5J5j3-ofaWAPLensj3Sd2fD4fMiU9Hc2AFbNuayl0HF2mqC9mE8UqKNszvaoYoyKrbHsedOFAyLeTOW0OIjaG685AOk408gLQscjgrvrYj_3gkTF8L8Vm/s400/Estonia+Corporate+Borrowing+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5561356536236457442" border="0" /></a><br /><br /> <br /><br />or about households:<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhXskMPz29L8eJUeL9W5dxYyDFe3l67l4tQ_DaYcdMN0tzaqhTwZMnh0G1WquHeuoqE88l8qDs-BmqVupkRBpJOzhP6wXgAWtHK5itVs2KDQV0zRv7_Ri5iG60RVzm-wi7g87vraAfXg1c8/s1600/Estonia+Household+Borrowing+y-o-y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 205px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhXskMPz29L8eJUeL9W5dxYyDFe3l67l4tQ_DaYcdMN0tzaqhTwZMnh0G1WquHeuoqE88l8qDs-BmqVupkRBpJOzhP6wXgAWtHK5itVs2KDQV0zRv7_Ri5iG60RVzm-wi7g87vraAfXg1c8/s400/Estonia+Household+Borrowing+y-o-y.png" alt="" id="BLOGGER_PHOTO_ID_5561356816035947234" border="0" /></a><br /><br /> <br /><br />or about housing mortgages:<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh4FTzHnqh-B6foEbQlTT_hcuVICwZfv2Dk7C-N4jAJmh4SylJ6g_wBDU3M5ugfywkjjwpwG1e7IX1sM-ipw9y98iUDmYKfiAMW4GSdMhNKNQXkdSpJ1FJ9bhnYXRCY7Yf2PRMzzEzVJTPg/s1600/Estonia+Mortgage+Lending.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 205px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh4FTzHnqh-B6foEbQlTT_hcuVICwZfv2Dk7C-N4jAJmh4SylJ6g_wBDU3M5ugfywkjjwpwG1e7IX1sM-ipw9y98iUDmYKfiAMW4GSdMhNKNQXkdSpJ1FJ9bhnYXRCY7Yf2PRMzzEzVJTPg/s400/Estonia+Mortgage+Lending.png" alt="" id="BLOGGER_PHOTO_ID_5561357052126141698" border="0" /></a><br /><br />Added to this, the way that fiscal austerity was implemented (raising VAT, and fuel costs) has meant that the Estonian price level, far from continuing to deflate (which is what is needed to increase competitiveness quickly enough) is now rising again, and at around 5.5% (my estimated HICP, <a href="http://www.balticbusinessnews.com/article/2011/01/07/Estonian-consumer-prices-up-5-7-in-December-yoy">the Estonian CPI was up 5.7% but the weightings are different</a>) is well above the 2.2% estimate for the Euro Area, or the 1.9% December inflation estimated for Germany by the Federal Statistics Office. Perhaps one of the clearest indications of the malfunctioning of the Eurozone as currently structured is that the Germany economy (which is recovering rapidly) is experiencing far higher levels of inflation than the Eurozone periphery, which in theory should be deflating to recover competitiveness.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlEePHzO5NSV844W54_0YaK_I_9TNxQkk7ghJOAiGSeFcWyEQW-PPVUc5ZbcXFYTtKBYZqn1bwo8THWHWFnysD_hvek0QBXl6kKHfGFOsVLQ54uuqbPzIYWpmcrjUKTQClg73WnhHatId1/s1600/Estonia+%2526+EA16+inflation+compared.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlEePHzO5NSV844W54_0YaK_I_9TNxQkk7ghJOAiGSeFcWyEQW-PPVUc5ZbcXFYTtKBYZqn1bwo8THWHWFnysD_hvek0QBXl6kKHfGFOsVLQ54uuqbPzIYWpmcrjUKTQClg73WnhHatId1/s400/Estonia+%2526+EA16+inflation+compared.png" alt="" id="BLOGGER_PHOTO_ID_5561357269069019970" border="0" /></a><br /><br /> <br /><br />True Estonia did begin to recover some part of the lost competitiveness, and unit labour costs as compared with some key competitors did start to improve, but this process slowed considerably in the first two quarters of 2010, marked time in the third one, and may actually have started to deteriorate again in the final quarter as inflation accelerates (OECD data - please click on image for better viewing).<br /><br /> <br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiYonB2EqHsytgqGxHZzI5dskOXEx2h6RwjsziuwXSx74GOmsfVxYNnWte15__DvdoW5JMxK-ve0MjpYSgPOqxkpP8rSzEuvnwwooRCEfM4GIq-jOMsbGUvQhg8jdq6RX74PB2iXfdaARcp/s1600/Estonia+Unit+Labour+Costs.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 243px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiYonB2EqHsytgqGxHZzI5dskOXEx2h6RwjsziuwXSx74GOmsfVxYNnWte15__DvdoW5JMxK-ve0MjpYSgPOqxkpP8rSzEuvnwwooRCEfM4GIq-jOMsbGUvQhg8jdq6RX74PB2iXfdaARcp/s400/Estonia+Unit+Labour+Costs.png" alt="" id="BLOGGER_PHOTO_ID_5561641691010523842" border="0" /></a><br /><br /> <br /><br />Hourly wages (on a moving average basis) seem to have stopped falling, and the next move will almost certainly be up as inflation bites in.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgy40Ww8IsVUCiGJ3anu8AUxULCplVk6OxHeSX7UW5Uslja4XDQ6GmGp_WKb_3EJpVgMqrSv9GOdz19U1puwsaharCD0I72zipeaaBO0mBlfDvzJxpFPBktyhtD5e2bgZaOw_ZpHSTctgw9/s1600/Estonia+Hourly+Wages.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 259px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgy40Ww8IsVUCiGJ3anu8AUxULCplVk6OxHeSX7UW5Uslja4XDQ6GmGp_WKb_3EJpVgMqrSv9GOdz19U1puwsaharCD0I72zipeaaBO0mBlfDvzJxpFPBktyhtD5e2bgZaOw_ZpHSTctgw9/s400/Estonia+Hourly+Wages.png" alt="" id="BLOGGER_PHOTO_ID_5561646496031827714" border="0" /></a><br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQf4QWjdAH16gsJN-zEJC63jxpOAqHEr5T6UE4lBaBltT6XXTLW3XvOVjzTOLQ5E9zEwJDoTkL21d-WquaSXfClA4upuqEC3ZnURGH1plO8mh8QyR667Tzaqaqy-vDsXac3gljzfOtR1_K/s1600/Estonia+Hourly+wages+y-o-y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 261px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQf4QWjdAH16gsJN-zEJC63jxpOAqHEr5T6UE4lBaBltT6XXTLW3XvOVjzTOLQ5E9zEwJDoTkL21d-WquaSXfClA4upuqEC3ZnURGH1plO8mh8QyR667Tzaqaqy-vDsXac3gljzfOtR1_K/s400/Estonia+Hourly+wages+y-o-y.png" alt="" id="BLOGGER_PHOTO_ID_5561644946397164418" border="0" /></a><br /><br /> <br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBe-UsX0EcQ2VLbpZZl70vjQJn2EPb4wvqcxVRI4ccYuIhLn_dxIVQjkhhHud3iqcEoUonfExDpAi_Guez7cdVqLtXN-0Q5-pG8IEuCoj3Iqe85pNN-XtTPWxr6DyMCJKdDSqCo3bALb8w/s1600/Estonia+PPI.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 233px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBe-UsX0EcQ2VLbpZZl70vjQJn2EPb4wvqcxVRI4ccYuIhLn_dxIVQjkhhHud3iqcEoUonfExDpAi_Guez7cdVqLtXN-0Q5-pG8IEuCoj3Iqe85pNN-XtTPWxr6DyMCJKdDSqCo3bALb8w/s400/Estonia+PPI.png" alt="" id="BLOGGER_PHOTO_ID_5561647062992033138" border="0" /></a><br /><br /> <br /><br />True, the Central Bank would undoubtedly argue that much of the inflation was due to food and energy, and that core inflation was running much lower (1.2% in November), but it is hard to see the impact of movements in the leading CPI not feeding through into wages, and producer prices (another important measure of industrial costs) were up an annual 4.5% in November.<br /><br /> <br /><br /> <br /><br /><b>And Its A Hard Road To Travel!</b><br /><br /> <br /><br />In his most recent assessment of the Estonian situation (<a href="http://blog-imfdirect.imf.org/2011/01/07/toughing-it-out-how-the-baltics-defied-predictions/">Toughing It Out: How the Baltics Defied Predictions</a>) <a href="http://blog-imfdirect.imf.org/bloggers/christoph-rosenberg/">Christof Rosenberg</a> (former coordinator of the IMF baltic intervention, and current head of the Fund's Hungary mission - this man also likes hard challenges!) also pays hommage to the grit and flexibility of the Baltic populations (a characteristic I also wholeheartedly applaud), but he draws a conclusion which I feel is as yet at best premature.<br /><br /> <br /><br /><blockquote>"The Baltic experience demonstrates that large economic adjustment, including nominal wage and benefit cuts, is indeed possible under a currency peg (or, for that matter, in a currency union)".</blockquote><br /><br /> <br /><br />Certainly, as Christoff points out, a large correction has taken place in Estonia. The current account, for example, is now in surplus.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj3H8BootUCPvIepZocUxVxzkEr9mdwNZ8DED91dl0ByLS9Y4kKSSvmPE5B7DAlG8pkxWuvYuV1anCjmQyu59SfAPwjjKrBaXjiL836vdBZTlG8peKfStpuhKrCLBMguptDWkiPqqv4iy4Q/s1600/Estonia+Current+Account+%2528monthlyl%2529.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 212px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj3H8BootUCPvIepZocUxVxzkEr9mdwNZ8DED91dl0ByLS9Y4kKSSvmPE5B7DAlG8pkxWuvYuV1anCjmQyu59SfAPwjjKrBaXjiL836vdBZTlG8peKfStpuhKrCLBMguptDWkiPqqv4iy4Q/s400/Estonia+Current+Account+%2528monthlyl%2529.png" alt="" id="BLOGGER_PHOTO_ID_5561652201140060690" border="0" /></a><br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhu1AqAGDMNki6EHTzrMgNbaItKNwIFex-TtB1Zqwuet4pCHLmwRNk_Tg28eroVkq8Qv4xJubUCjdFWRVWJWDicKLz0YYv8J4l3K0tCWHRALZbgZfn55DylQUD2Yr-Fjristnm1petVQR3q/s1600/Estonia+Current+Account+%2528annual%2529.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 253px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhu1AqAGDMNki6EHTzrMgNbaItKNwIFex-TtB1Zqwuet4pCHLmwRNk_Tg28eroVkq8Qv4xJubUCjdFWRVWJWDicKLz0YYv8J4l3K0tCWHRALZbgZfn55DylQUD2Yr-Fjristnm1petVQR3q/s400/Estonia+Current+Account+%2528annual%2529.png" alt="" id="BLOGGER_PHOTO_ID_5561651445249692962" border="0" /></a><br /><br /> <br /><br />The issues I am raising is whether this correction is enough, or whether it is sustainable. As <a href="http://www.eestipank.info/pub/en/press/Press/pressiteated/pt2010/_12/_259.html">the Bank of Estonia note</a>, the Non-performing loans situation has been stabilised, and the value of loans overdue for more than 60 days contracted by over 250 million kroons in November to stand at 6.8 per cent of the total loan portfolio. But most of the old loans are still there, they have not been cleaned from the books, and have been sustained and refinanced by what Christoff calls the "deep pockets" of the Scandinavian lenders. These loans would be once more put into question by any renewal of the internal devaluation and serious price deflation. So hard decisions are going to need to be taken.<br /><br /> <br /><br />Inflation is already excessive, and net-exports are nowhere near large enough as a proportion of GDP to carry the economy forward with a strong growth dynamic. Indeed the IMF itself is forecasting a return of growing current account deficits after 2013, which should alert us to the fact that all is not yet as it should be, by a long way. Thus, in conclusion, I think it is very true to say, as Christof does, that it still far too early to pass any kind of definitive judgement on the success or otherwise of what he calls "the Baltic strategy". There is still a very long hard road out there in front, and the hardest and steepest part may well be yet to come.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-5589643901635157232011-01-08T10:03:00.000-08:002011-01-08T10:20:57.005-08:00Turkey's Audacious Experiment In "Post Modern" Monetary Policyby Edward Hugh: Barcelona<br /><br />The recent decision of the Turkish Central Bank to lower rather than to raise interest rates in an risky attempt to quench the inflation flames that many feel are threatening to engulf what <a href="http://www.google.com/url?sa=t&source=news&cd=2&ved=0CCkQqQIwAQ&url=http%3A%2F%2Fonline.wsj.com%2Farticle%2FSB10001424052748704034804576025082119095912.html&ei=T7IZTdePAcidOrT0weMI&usg=AFQjCNEnH0t9ywh38fYy9LCnbwfCVj5RUg">some call an "overheating" economy</a> (or <a href="http://www.google.com/url?sa=t&source=news&cd=4&ved=0CEoQqQIwAw&url=http%3A%2F%2Fblogs.ft.com%2Fbeyond-brics%2F2010%2F12%2F10%2Fturkey-high-growth-fuels-rate-dilemma%2F&ei=T7IZTdePAcidOrT0weMI&usg=AFQjCNEelrItvoNwlFDd1SaIHk127hQl9A">here</a>) has lead to a good deal of heart-searching and consternation in the economic and financial press of late. After all, at the end of the day aren't they doing exactly the opposite of what the text book says they should? Well, as is usual in the realm of the dismal science, all is not exactly what it seems to be.<br /><br />To put the issue in some sort of context, the background to this decision is undoubtedly Ben Bernanke's move in early November to extend US monetary easing, by going one bridge further in his assault on the housing deflation and continuing high unemployment which weigh down the economy by introducing what effectively amounts to a second round of exceptional policy measures (<a href="http://fistfulofeuros.net/afoe/an-unusual-but-interesting-argument-which-may-help-to-understand-why-qe2-is-now-almost-inevitable/">known coloquially as QE2</a>). The leading objective behind this move was to increase the amount of liquidity available in the US economic and financial system, although a more covert consideration was cleary to weaken the dollar in an attempt to boost exports and use the strength of external demand to tow the US consumer back towards growth territory. Joining up the dots, we find that the key link between these two otherwise seemingly unrelated central bank decisions (after all one is concerned with an economy which is growing too slowly, while the other is working with one which may be growing too quickly) is to be found in the fact that the US economy is already saturated with as much liquidity as it can handle (in terms of the capacity for absorbtion of the domestic sector) and as a result the funding made available works its way through to more attractive, and more profitable outlets across the developing world.<br /><br />So what has happened in practice is that large quantities of liquidity have been been seeping out of the back door, some of it undoubtedly heading over to Europe in the search for the reasonably safe but still quite attractive pickings which have become available due to the Sovereign Debt Crisis, but the lions share is surely making its way towards those, seemingly "risky" rapidly growing emerging economies.<br /><br />This has lead to a certain amount of angst and confusion among developed economy political leaders, with Angela Merkel, among other European politicians, voicing the complaint that the financial markets are effectively "mispricing" risk. Personally, I don't claim to have any special insight into whether or not the markets are pricing risk well, or badly. I would have thought that that was exactly why we had markets in the first place (rather than a centrally planned pricing mechanism): to put a price on risk. But that being said, the systematic downgrading of the ageing developed world and the systematicup grading of the youthful "growth" economies in the third world has a certain logic to it.<br /><br />Obviously, in a world which is as rapidly changing as ours is, markets need time to adjust. And market participants are evidently a vulnerable as anyone else is to the human failing of getting things wrong. Markets are not superhuman entities, their outcomes are the aggregated product of a very large number of individual human decisions. But I think it is important here that all concerned recognise their own limits and limitations. It is either an extremely bold or an extremely foolish politician who feels equipped to move to a higher level to pass judgement on a process whose outcome is still remains an open question. Post hoc, as we have seen in the wake of the recent financial crisis, there is no shortage of critical voices, and all and sundry have a notable facility to point the accusing finger to tell the markets "you got it wrong"! But telling them you have it wrong before the event, well that takes gall! And if you are really so sure, then put your money where your mouth is, and buy up all that debt the markets evidently don't want.<br /><br />In fact, markets are neither omniscient, nor omnipotent, and often move as much behind the curve as they do in front of it, correcting to changing undelying realities in a herd-like fashion and even then only after a time lag. Yet, as I say, there is a certain logic behind the most recent trend, which involves repricing risk in the developed economies (due to their ageing populations, and large uncovered obligations with the future, issues whose importance was not sufficiently appreciated and accounted for in the pre-crisis world ), at one and the same time that risk in the developing world is also repriced, since emerging market "risk" may not be quite so risky as the "old normal" mindset used to think it was.<br /><br />As a result, a number of key emerging economies find themselves in the pleasant position of enjoying the benefits of a win-win dynamic, since far from struggling with ever higher elderly dependency ratios, the proportion of their population in the labour force (and also in employment) is now rising constantly, while both inflation and interest rates (including ones related to country risk) are trending downwards in the longer run. Turkey is, in fact, one of these fortunate economies, which is why I think the latest move from the Turkish central bank needs serious consideration, and should be understood not as just one more piece of "midwinter madness", but rather seen as part of a much more calculated and comprehensive strategy which comes from a modern and continually evolving tool set. New problems need new remedies, so let's leave small open (and even large open) economies where they belong: in the unreal world of the academic textbook. In today's world interest rates are not set locally, and excessive domestic inflation is often produced more by the dynamics of global capital flows than by the irresponsible spending decisions of local politicians. Which is not to say that the Turkish central bank have the balance right (or wrong), but simply to state that global problems require global solutions, and in the meantime, national leaders will have to adapt their policy mix to confront new problems, problems which but a few short years ago would have seemed almost unimaginable.<br /><span style="font-weight: bold;"><br />Complex Problem Set With A Positive Outlook</span><br /><br /><br />As Erdem Basci, deputy governor of the central bank recently argued, strong capital inflows (see chart below), fuelled by quantitative easing in developed economies, are in danger of producing the undesireable outcome of distorting economic development in emerging economies and potentially fuelling asset bubbles in the longer run. According to Basci, as argued in a posting on the central bank website, the best policy response to this thoroughly modern problem is to try to make these countries less attractive to short-term investors by cutting interest rates in a step-by-step process (a move which would also make the country more attractive to longer term investors - think FDI), while making extensive use other tools to attack the excess liquidity problem and restrain domestic credit growth.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgnTENI55AcQ3rTgGpUtTCarMw8JzEPS3vS1X55vyl2V7iSVa3DA3EY63z35XQec5kh7W5dOw1eTGLH0aJpCFV_0YQZowbSvLw1-JK42k3XpEeiLUNr_1nY_wt8bUvxZZ8NwnlRcMysHgY/s1600/Turkey+Central+Bank+Reserves.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 237px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgnTENI55AcQ3rTgGpUtTCarMw8JzEPS3vS1X55vyl2V7iSVa3DA3EY63z35XQec5kh7W5dOw1eTGLH0aJpCFV_0YQZowbSvLw1-JK42k3XpEeiLUNr_1nY_wt8bUvxZZ8NwnlRcMysHgY/s400/Turkey+Central+Bank+Reserves.png" alt="" id="BLOGGER_PHOTO_ID_5553423348877688642" border="0" /></a><br /><br />And so it was to be, since the central bank's monetary policy committee voted at its most recent meeting to cut the reference lending rate by 0.5% (to 6.5%). This move was rapidly followed by the second of the steps advocated by Basci, since the bank then announced that the required reserve ratios (RRRs) for Turkish banks would be lifted to 8%, a move was expected to drain an estimated 7.6 billion Turkish lira (or $4.9 billion) from the economy in one foul swoop, with the objective of reducing the amount available for Turkish banks to lend to their clients.<br /><br />Now in order to make sense of this decision, the key point to grasp is that Turkey's economy <span style="font-weight: bold;">is not, in fact, currently overheating</span>. At the present time, the very opposite is happening, since the economy has been slowing, with the quarter-on-quarter growth rate falling in the third quarter to a "mere" 1.1%, down from the sweltering "China like" pace of 3.7% clocked up between April and June. Now a 1.1% quarterly GDP growth rate (or a 4.4% one annualised) is not exactly small beer by present developed economy standards, but it certainly is <span style="font-weight: bold;">not</span> overheating territory for an economy in the process of making the shift from underdeveloped to developed status in the way that Turkey's is.<br /><br />Nor is inflation showing signs of getting out of hand. True, at around 7% it is still stubbornly high, but it has been stabilised, and shows no sign of getting out of hand, while the core inflation rate has been falling steady, and is now around 3%. So while the situation signals caution, it hardly cries out for drastic monetary tightening.<br /><br />So what the recent decision was really about was not an attempt to conform with the objectives of conventional monetary policy, rather the move was intended to dissuade and deter speculative investments looking for higher yields from continuing to pour into Turkey and magnifying the economy’s key weakness: <span style="font-weight: bold;">the mushrooming current-account deficit</span>. The idea was to reduce the yield differential with lending rates in the quagmired developed economies.<br /><br />So the problem facing Turkey's policy makers is not the economy isn't growing, or that it is growing too quickly (there is plenty of spare capacity left out there), rather the problem is that <span style="font-weight: bold;">it is growing in an unbalanced way</span>. The high yield differtial, and the funds inflow which it is producing, means that the currency is appreciating even while inflation remains excessively high (now stuff that in yourtext book and smoke it), and this combination is a sure fire way <span style="font-weight: bold;">for the export sector to lose competitiveness</span>. And this is in fact what is happening, as imports (driven by the consumer credit boom) surge, while exports fail to keep pace, with the result that the trade balance deteriorates, and along with it the current account one.<br /><br />But as Erdem Basci among others, including some IMF economists, argue, hiking interest rates could be totally counterproductive in the current climate since it might well serve to make the country even more attractive (by <span style="font-weight: bold;">increasing that key yield differential</span>) to precisely the kind of funds they want to deter. Turkey, as many analysts constantly point out, has become <span style="font-weight: bold;">over-dependent</span> on the wrong kind of funding to finance its current account deficit. What Turkey needs is to attract longer term investment finance, and while reducing the volume of short term speculative finance which is currently distorting prices in the country's equity markets. This argues for lower, not higher, interest rates, since bringing the longer run cost of borrowing down should make the country more attractive to the kind of investor it needs.<br /><br />So the bank have decided to adopt a monetary experiment based on a resort to other measures, and the first of these is an attempt to withdraw some liquidity from the banking system. One of the principal worries is that the rapid expansion in the volume of domestic credit has triggered a rise in imports and thus aggravated the deterioration in the current account deficit. But the problem is not only a current account deficit one. The following chart (prepared by staff at the Turkish economicresearch institute TEPAV) shows that the credit expansion is also associated with a rise in the systematic risks of the banking sector, since much of the lending is evidently being financed by short term fund flows.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjR6q2qMONkET9b5B4dZ34DsE6ipvhsGOEjfCRkoINwuvZtapbWEjSWZHqg_toMgKUZDxTDasXDgU71xb581OP66cgNvC7gg5ACwUawYXVBIMEF383esxzdIw622AdiA-PX4CUwCZ6F8hk/s1600/Foreign+Fund+Flows.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 188px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjR6q2qMONkET9b5B4dZ34DsE6ipvhsGOEjfCRkoINwuvZtapbWEjSWZHqg_toMgKUZDxTDasXDgU71xb581OP66cgNvC7gg5ACwUawYXVBIMEF383esxzdIw622AdiA-PX4CUwCZ6F8hk/s400/Foreign+Fund+Flows.png" alt="" id="BLOGGER_PHOTO_ID_5559833935586402146" border="0" /></a><br /><br />[Please Click on Image to View More Clearly]<br /><br />Net foreign financing of Turkey's banking sector hit US$17 billion in the last quarter of 2008. Subsequently the level fell rapidly, but with the economic recovery foreign funding has once more been on the increase, an as of October 2010 it was in the region of US$22.5 billion. One important characteristic of the foreign funding the Turkish banks have been accessing since the advent of the recovery is that something like 98 percent of the funds are short term. This sharp rise in short term funding is not only unprecedented, it is also highly dangerous, since were there to be a sudden change in risk sentiment (due to factors which had nothing directly to do with Turkey itself), such funding might not be renewed, leading to a maturity mismatch between the banks' borrowing and lending which could severely strain the Turkish financial system.<br /><br />The central bank is therefore pretty concerned to slow the rate of credit expansion, and with this in mind it has also introduced a second bloc of measures involving steps to contain the rate of expansion in consumer credit - credit card restrictions, increased loan to value ratios in house purchase, etc. Due to the endless ability of those who are smart enough to find ways to get round such rules, none of these are perfect, but they are a lot better than nothing, and nothing, some will remember, was those responsible for managing the Spanish and Irish economies did when their credit and indebtedness ratios were obviously on the verge of getting out of control, and when the relevant central bank seemed to see no inconvenience at all in applying negative interest rates to their already credit-bloated economies. So by all means criticise the Turkish central bank, but let's be clear what (and who) we are comparing them with.<br /><br />Obviously additional measures could and should now come from the Turkish government. Measures which involve the judicious (and even aggressive) use of fiscal policy to drain in the most direct fashion excess demand from the system. In this context it is pleasing to be able to note (see below) that this year's strong rise in tax revenues is not being matched by an equivalent increase in spending. Indeed the country is now running a quite strong primary budget surplus. More of the same, and then some, is what we need to see, but with elections looming it is doubtful decisive steps will be taken until the new government is formed.<br /><br />And it isn't only rapidly growing credit that is a concern, a lot of the money has gone into Turkish stocks which are now not far off their 2008 pre-crisis highs. In fact foreign purchases of Turkish financial assets rose to around $15.5 billion in the first 10 months, from $730 million a year earlier, according to central bank data. In October alone, international investors bought $969 million in shares and $1.5 billion in government bonds.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgi361S1nbqKt6W14I7KJYeZjz7W7TaO3wr-Htg10czFIC-MiTRlen3ELApkiEKgHg7Mpsw9MwiaO83JMAmrTZnT27w4XDhFRrQYTcGJQv9uaY5FdrUB0cmvZ10nj5ZoAfhBNBPVFwYXNA/s1600/Turkey+MSCI+Core+Index.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 237px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgi361S1nbqKt6W14I7KJYeZjz7W7TaO3wr-Htg10czFIC-MiTRlen3ELApkiEKgHg7Mpsw9MwiaO83JMAmrTZnT27w4XDhFRrQYTcGJQv9uaY5FdrUB0cmvZ10nj5ZoAfhBNBPVFwYXNA/s400/Turkey+MSCI+Core+Index.png" alt="" id="BLOGGER_PHOTO_ID_5559871621152415250" border="0" /></a><br /><br />Summing up, it is hard to say at this point whether the Turkish central banks attempt to operate what some have called a "post modern" monetary policy will work exactly as intended, especially since the outcome is not directly in the hands of the central bank, and very much depends on the determination of the government to take the necessary measures on the fiscal side. But whatever the outcome, of one thing we can be sure: <span style="font-weight: bold;">doing something always has to better than doing nothing</span>. After all, who else would knowingly and willingly wish to end up in the kind of unfortunate situation Spain and Ireland now find themselves in?<br /><span style="font-weight: bold;"><br /><br />The Economy Has Surpassed Pre-Crisis Levels, And Is Now In Full Recovery Mode</span><br /><br /><br />Turkey's economy slowed in the third quarter, and the pace of GDP growth slipped back to a calendar adjusted 6.4% year on year in the third quarter, down from the China like 10.2% pace registered in the second one. The key to the slowdown was the deterioration in external trade: exports dropped by 2% year on year, the sharpest contraction since the third quarter of 2009, while import growth remained in double-digits for a fourth consecutive quarter (albeit slowing marginally to an annual increase of 16.9% from 18.8% in the second quarter).<br /><br />Final domestic demand growth, on the other hand, strengthened to 11.2%, its fastest pace of advance in more than four years. Private consumption growth was strong, and surged by 7.6%, but the heavy lifting seems to have been done by investment (much of it in construction), with an increase in gross fixed capital formation of 31.3%. Even if the underlying housing boom offers the explanation for much of this growth, capital goods investment was also strong, as shown by the fact that the import of capital goods rose by an annual 31.3%.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjGFy4q8j8aNBwH48WEzw1bFqBrP9-6EKaC3Q1nH0X56Mn_BkEjhXr7xGjz9-zJPnGgf4CbSNvZmX1m2MCWUVR7ETBA81ANvvmPWUuuRb8f0mYjk7tNTHiKFaQQZU6-twZ_UWUiKGaLOeM/s1600/Turkey+GDP+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjGFy4q8j8aNBwH48WEzw1bFqBrP9-6EKaC3Q1nH0X56Mn_BkEjhXr7xGjz9-zJPnGgf4CbSNvZmX1m2MCWUVR7ETBA81ANvvmPWUuuRb8f0mYjk7tNTHiKFaQQZU6-twZ_UWUiKGaLOeM/s400/Turkey+GDP+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5553435788007248562" border="0" /></a><br /><br />In fact, the most worrying part of the Q3 performance was not the fall in exports, it was the surge in imports, and the impact this is having on the trade and current account balances. Correcting this disturbing trend must now be one of the most important policy priorities for Turkish decision makers. Consensus forecasts now suggest Turkey could well grow by an annual 7% this year (up from an earlier expectation of 6%) and this does not seem to be at all unreasonable,<br /><br />Whatever the weaknesses, the big picture story is that Turkey’s economy is once more growing dynamically and reaching new highs. Real economic gains are being made and we now are seeing increasing evidence of a true recovery which goes well beyond the confines of a simple statistical rebound.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQybgzI7yyj-3LXoSIwcg1B4D99pZRY_Cfp7bqqcvH2_-fCV2bfqit0EGVC-33cASQw7KORDztARnVbU0x9X2qZWDOC3KQVhwYthjUeQrZ9no7Nck3IyhziTfcMxUz1WCf0Uky5Xnw5wQ/s1600/Turkey+Constant+Price+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 224px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQybgzI7yyj-3LXoSIwcg1B4D99pZRY_Cfp7bqqcvH2_-fCV2bfqit0EGVC-33cASQw7KORDztARnVbU0x9X2qZWDOC3KQVhwYthjUeQrZ9no7Nck3IyhziTfcMxUz1WCf0Uky5Xnw5wQ/s400/Turkey+Constant+Price+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5553444486064131650" border="0" /></a><br /><br />But a dose of realism is called for. Despite the fact that the economy will in all probability now grow by at least 7% in 2010, in 2011 Turkish growth rates will undoubtedly continue to drop back from the very high level seen in the first half of this year, but if this weakening in headline GDP numbers is simply the result of a deteriorating net trade position then we will have the worst of both worlds, as debt driven consumption growth will be faster than desireable, while the export sector will continue to weaken, even as import substitution undermines the domestic industrial sector. Unchecked this could lead to the same sort of manfuacturing industry job loss we have seen across Southern Europe over the last two decades.<br /><br />On the other hand, the Turkish economy is likely to continue turning in an impressive performance, one which will stand out among regional peers since sustainable trend growth in Turkey remains high. If adequate steps aretaken to rein-in the current account deficit, and to attract more in the way of job-creating FDI, 6% growth could well remain a realistic target for 2011, even if there is a deterioration in the external environment and a weakening in the level of external demand.<br /><br />One factor which makes Turkey stand out from many of its regional peers is that it is not overly export-dependent and has a dynamic domestic economy which complements the export sector. This means that the Turkish economy basically stands upright, and on both feet, and that, despite the recent loss of export competitiveness the impetus behind GDP growth is much more broadly-based than in the other, heavily-indebted countries which can be found in the surrounding region. In addition, the underlying strength of domestic demand means the Turkish government has a far broader, and ever-growing, potential tax base. This makes it much easier to attain longer term fiscal stability, and means that the country does not have to continually stagger forward on the basis of a series of “one off” measures to keep the deficit undercontrol.<br /><br />To some extent the slackening in Turkey's growth performance is only to be expected, since, in terms of external demand (and as in many other economies) all the "low lying" fruit has now been picked as exports have steadily attained their previous level. Reaching out for the rest will now become more and more difficult, especially with so much "deleveraging" going on in the neighbourhood, and so many export dependent economies in the region, which is why the export competitiveness issue needs to be so strongly stressed.<br /><br />Thus, while Turkey turned in an 11.7% annual growth rate in the first three months of the year, and then followed up with an impressive 10.3% in the second three – a rate only equalled by China among the major economies – the calendar adjusted 6.4% rate registered between July and March is better read as a return to normality rather than the commencement of a serious slowdown. Quarter on quarter the economy grew by a seasonally adjusted 1.1%, and output was still up by 8.2% in the first nine months of the year over the equivalent period in 2009.<br /><br />On top of this, the economy is now reaping the long run fruits of major macro economic restructuring in the early years of this century, while in addition the country faces a very favourable demographic evolution. The result of this very fortunate combination is that the dollar denominated value of Turkish GDP is now very substantially above where it was ten years ago, and now that the recession is behind us it should continue to rise rapidly.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEizOxIm5UrCjdzIz0S8dA8yiAg14YWipufhqOR3Q63vN3BL6_O0R87JGJ-FB4yFTx8MFrAlmBAfRJYGFhWOfSUvHceLSGH7QMtwCBSGba2dCDwJOQwcnBRIEy6N0-eqUbLC3GIhSls-NHc/s1600/Turkey+Dollar+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEizOxIm5UrCjdzIz0S8dA8yiAg14YWipufhqOR3Q63vN3BL6_O0R87JGJ-FB4yFTx8MFrAlmBAfRJYGFhWOfSUvHceLSGH7QMtwCBSGba2dCDwJOQwcnBRIEy6N0-eqUbLC3GIhSls-NHc/s400/Turkey+Dollar+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5553453575415052498" border="0" /></a><br /><span style="font-weight: bold;">Current Account Woes</span><br /><br /><br />Throughout this year the negative balance on Turkey’s current account has steadily worsened, and the trailing 12 month deficit total in October was around $40 billion, or 5% of GDP. This underlying deterioration in parts reflects the country’s energy dependence and the impact of rising fuel costs, but it also gives a measure of the strength of the domestic consumer rebound coupled with the impact of the inflation-driven real exchange rate appreciation.<br /><br /><br />Turkey has had a long history of persistent current account deficits, and as might have been expected while the problem eased during the recession, the arrival of the recovery slammed issue straight back onto the table. During last year’s sharp contraction, Turkey’s current account deficit fell back to 2.3% of GDP, and the topic moved quietly off everyone's radar. But last year's reduction was due to very exceptional circumstances (the sharp contraction in domestic demand during the global financial crisis), so this years widening of the deficit to a level which could eventually be as high as 6% of GDP (or even slightly over) is essentially a reversion back to type. Which does not make it any the less problematic.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj9peay5i-LNwsXZI8Rt2NmUMh_XqqoJvrnr0tqp6DQcSKdzjuGGFHTAbLaKUCArMTgKY5Hute97PK_VHeS3YhI6W-aXqshFmANWWBSPIy1C8NtlXA4eugBFwAi4Dplcf9aNhjgB_BZt3k/s1600/Turkey+Current+Account+Monthly.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 233px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj9peay5i-LNwsXZI8Rt2NmUMh_XqqoJvrnr0tqp6DQcSKdzjuGGFHTAbLaKUCArMTgKY5Hute97PK_VHeS3YhI6W-aXqshFmANWWBSPIy1C8NtlXA4eugBFwAi4Dplcf9aNhjgB_BZt3k/s400/Turkey+Current+Account+Monthly.png" alt="" id="BLOGGER_PHOTO_ID_5553455551831806162" border="0" /></a><br /><br />When thinking about competitiveness, as well as simple exchange rate movements it is also important to take inflation differential's into account. Indeed the Turkish currency has been weakening recently on the back of the European Sovereign Debt Crisis, and the lira fell to a five-month low against the dollar following the central bank announcement of the latest measures. But even prior to the rate reduction the lira had been falling, and is now down around 7.5% against the US dollar since November 4 as concern has grown about potential economic spillovers to Europe's trading partners from the growing problems in countries like Ireland, Spain and Portugal. Weakening European demand is not good news for Turkey, since Europe is Turkey's main trading partner.<br /><br />Thus while the lira rose by something like 9% against the euro last year the net 2010 gain against the dollar (before the post-November 4 slide) was only about 4 percent. However, given the much closer trade ties that Turkey has with the EU, it was the Euro rate which mattered for the export performance.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKL3Aph3IPUQ_SCPtWM2DCMLuLl4ZwpADzSMKuTOHrerhXzBWFfF7hZSLUq2nhy95t_RaAJWGJK5sht-ZZG1XqiMRTxE_59EPJsWeirKH_xp_fSEOwBlpMAz_eRorMfP31VankOs76u4I/s1600/Turkey+Lira.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKL3Aph3IPUQ_SCPtWM2DCMLuLl4ZwpADzSMKuTOHrerhXzBWFfF7hZSLUq2nhy95t_RaAJWGJK5sht-ZZG1XqiMRTxE_59EPJsWeirKH_xp_fSEOwBlpMAz_eRorMfP31VankOs76u4I/s400/Turkey+Lira.png" alt="" id="BLOGGER_PHOTO_ID_5553456700459649154" border="0" /></a><br /><br />Although Turkey's exports were up sharply in October (to $11 million), after several months stuck around the $9 million mark, the improved performance was not sustained, and in November they fell back again to around $9.4 billion.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhU3SBvAyUrFMyKj7qM3qM5T-gH71UGFTjUXXXuDCeQrFnjIjc3dYmqK8r6PoJd3sjEs6AJfJjgO5pixbYuq9mSUZKX-YFhHd0VpXKSksTcdEfFOOw2JwYLQtm2PoIphHHpBIhrqTBDmTs/s1600/Turkey+Exports.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhU3SBvAyUrFMyKj7qM3qM5T-gH71UGFTjUXXXuDCeQrFnjIjc3dYmqK8r6PoJd3sjEs6AJfJjgO5pixbYuq9mSUZKX-YFhHd0VpXKSksTcdEfFOOw2JwYLQtm2PoIphHHpBIhrqTBDmTs/s400/Turkey+Exports.png" alt="" id="BLOGGER_PHOTO_ID_5555729769735469762" border="0" /></a><br /><br />But of course, in the complete picture we would have to note that imports (and with them the trade deficit) have also continued to rise steadily, although at $17.1 billion in November, they were still some considerable way below the July 2008 high of $20.5 billion.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEivwNYDZbMb4CJ0XOaJeplE3jjgez2fuIwlfWglxTCFnfQiatj4fhQ5REsQrwFray8hxDYHqi2-Vr7T0Hhjz6a4vqDYDlUMZ8l0PEsXgxMRUgCnbS-hqfRBaH0PpdKZ8kQ-RMWJfNf5WiU/s1600/Turkey+Imports.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEivwNYDZbMb4CJ0XOaJeplE3jjgez2fuIwlfWglxTCFnfQiatj4fhQ5REsQrwFray8hxDYHqi2-Vr7T0Hhjz6a4vqDYDlUMZ8l0PEsXgxMRUgCnbS-hqfRBaH0PpdKZ8kQ-RMWJfNf5WiU/s400/Turkey+Imports.png" alt="" id="BLOGGER_PHOTO_ID_5553586911151128610" border="0" /></a><br /><br />The seasonally adjusted trade deficit has continued to deteriorate steadily since the recovery started in late 2009.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj38BY9DCu0M-yfkL2CHLmetQUwBZ04-bQpaODdRxoCwqPUptqD-btXH7ZZWaxJYKkjDU8x-mRVO9e5s3M_gj9Ey5-uf3q4EJVw8kLKxLhvQ_P4Ojj7klkfoY3AcalkQKdZtUIimNfNasA/s1600/Turkey+Goods+Trade+Balance.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 231px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj38BY9DCu0M-yfkL2CHLmetQUwBZ04-bQpaODdRxoCwqPUptqD-btXH7ZZWaxJYKkjDU8x-mRVO9e5s3M_gj9Ey5-uf3q4EJVw8kLKxLhvQ_P4Ojj7klkfoY3AcalkQKdZtUIimNfNasA/s400/Turkey+Goods+Trade+Balance.png" alt="" id="BLOGGER_PHOTO_ID_5559809055192954226" border="0" /></a><br /><br /><br /><span style="font-weight: bold;">Domestic Activity Also Rises</span><br /><br />The recent recovery in manufacturing activity continued at full pace in October, with industrial output posting an annual increase of 9.8%, well above the 6.1% market consensus expectation. Following a tame performance in September, where seasonally adjusted output stayed flat at the August level, production surged again in October, and by an eye-catching 3.1% on the month. It is worth noting that industrial production has now returned to pre-crisis levels, implying that (even though <span style="font-weight: bold;">overheating is not an issue</span> at this point) the output gap may be narrowing faster than central bank projections anticipate.<br /><br />The better-than-expected increase is largely due to a strong performance in both capital and consumer-durable goods. Capital goods were up by an annual 25.6%, and consumer durables by 21.7%. While the numbers for consumer durables reflect the expansion in consumer credit, the ongoing strong performance in capital goods suggests that the investment activity also continues apace.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxi76ffJXpgA6OetnVF-ctp36_yNpx6v1eISaqw_pqks-_pjW9klay4m0dx8qlhs90P-KBCZUTTvsAqBgr2x1yrlMc9qdhOL4ONECdD21MUCt1xTX-7Nh1ZqDDWr7sg11lWxH2328sx-g/s1600/Turkey+Industrial+Output+Index.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 240px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxi76ffJXpgA6OetnVF-ctp36_yNpx6v1eISaqw_pqks-_pjW9klay4m0dx8qlhs90P-KBCZUTTvsAqBgr2x1yrlMc9qdhOL4ONECdD21MUCt1xTX-7Nh1ZqDDWr7sg11lWxH2328sx-g/s400/Turkey+Industrial+Output+Index.png" alt="" id="BLOGGER_PHOTO_ID_5553587817771559730" border="0" /></a><br /><br />And the continuing strong performance registered in December's manufacturing PMI suggests the short term outlook for the Turkish industrial sector remains positive.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-hs6dVBQDHS2cxKhvpek-d5No5bZSSDLlZi9dQSLWMRwwgAdF0TWNfsQ51LqaE9MtnJbFKoOofYEFqYQcy15wkKkXwD6ISfrE9PIoTLO7IGFid8OVgOJSKq2gpjvw18F7Pf76ugBf6IA/s1600/Turkey.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 223px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-hs6dVBQDHS2cxKhvpek-d5No5bZSSDLlZi9dQSLWMRwwgAdF0TWNfsQ51LqaE9MtnJbFKoOofYEFqYQcy15wkKkXwD6ISfrE9PIoTLO7IGFid8OVgOJSKq2gpjvw18F7Pf76ugBf6IA/s400/Turkey.png" alt="" id="BLOGGER_PHOTO_ID_5559810783576721378" border="0" /></a><br /><br /><blockquote>Commenting on the Turkey Manufacturing PMI survey, Dr. Murat Ulgen, Chief Economist for Turkey at HSBC said:<br /><br />““The Turkish manufacturing sector maintained November’s impressive performance in December, expanding at its fastest rate since May. The pace of output and new order growth moderated slightly from the previous month, though still remained impressive. New export orders, on the other hand, showed the fastest improvement since October 2009. More encouragingly, this bright picture supported employment creation with conditions reaching their best level ever in the survey history. Backlogs of work increased marginally in December, while manufacturers continued to slash their finished goods inventories to meet order demand. In the meantime, this stellar performance also led to some price and margin pressures. Input prices soared at a very high rate, reminiscent of 2008 Q1 with rampant global commodity prices, whilst suppliers’ delivery times lengthened at a close to record rate. As such, manufacturers continued to reflect this in output prices that rose at the fastest pace in eight months.””</blockquote><br /><br />Surprisingly, while retail sales continue to grow steadily, up to now they have not been one of the leading drivers of the current expansion, as indicated by the fact that the third quarter increase was only 7.5% over a year earlier. Not bad by developed economy standards, but well short of the level of construction investment increase, for example.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEit4VIKcgmmEGmLko3wgTJogPlBtuqJK4593qb_3wPyFX9Tuo8KHMDYFkZY3o6okfkKYQYKdxXm1btH069zUj_n0lozvf1GVXXdwM2iyiK_CS8FGNET4yB47rfujn4ERgpvyBrqJE7ZRNc/s1600/Turkey+Retail+Sales.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEit4VIKcgmmEGmLko3wgTJogPlBtuqJK4593qb_3wPyFX9Tuo8KHMDYFkZY3o6okfkKYQYKdxXm1btH069zUj_n0lozvf1GVXXdwM2iyiK_CS8FGNET4yB47rfujn4ERgpvyBrqJE7ZRNc/s400/Turkey+Retail+Sales.png" alt="" id="BLOGGER_PHOTO_ID_5553594745308390898" border="0" /></a> <span style="font-weight: bold;">Unemployment Falls Even As The Labour Force Grows and Grows</span><br /><br />Still, the outlook on domestic sales continues to improve, and one of the principal reasons for this is the continuing fall in the seasonally adjusted unemployment rate, which was down to 11.8% in September. In fact unemployment peaked (on a seasonally adjusted basis) at 14.8% in April 2009, and has since been falling steadily, while the seasonally adjusted level of <span style="font-weight: bold;">employment</span> continues to rise. Such strongly positive co-movements in employment and unemployment evidently lead households to have an increased sense of job security and purchasing capacity.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjKwbwYtPY-gZy7XTzQnZ9H89UKkcjxX-k_GElHufOdhfHsKgk3d8camM5C6DGI4j_sghOc7VN12bJAPEfQOjkpi-jNU6YP-Uc7xDdztCVkweM9F7PImdaEe-njPxN4SbP-NGvIGleRrLM/s1600/Turkey+Unemployment+Rate+-+Eurostat.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjKwbwYtPY-gZy7XTzQnZ9H89UKkcjxX-k_GElHufOdhfHsKgk3d8camM5C6DGI4j_sghOc7VN12bJAPEfQOjkpi-jNU6YP-Uc7xDdztCVkweM9F7PImdaEe-njPxN4SbP-NGvIGleRrLM/s400/Turkey+Unemployment+Rate+-+Eurostat.png" alt="" id="BLOGGER_PHOTO_ID_5553601040359944386" border="0" /></a><br /><br /><br />The country has been creating and continues to create jobs in large numbers. When compared with September 2009 the number of those employed rose by nearly a million (to around 23 million), with the share of those occupied in the industrial sector (around 20%) rising significantly.<br /><br />Under the impact of the global financial crisis, Turkey’s unemployment hit a record high of 16.1% in February 2009. A year and a half later, and in sharp contrast with most of its regional peers, the country has achieved an impressive drop in its jobless rate. Even more significantly, Turkey has achieved this improvement at a time when the size of the labour force has been rising sharply, from 51.3 million to 52.7 million. This is yet another example of how Turkey is in a very different position to its regional peers, most of whom face ageing and declining labour forces due to their negative demographic trends.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYnTZP1DhH7L4KNm2zrnOV_Am4Z8rEAUnIncbusUlAKcP6RIZstLfaXxDG7fL_JsdhUljHRobwyFg7dQwjdVJtRkmV0A7Y8SliFWdDx8hnIt8ZebHsBs32U33MYxOWIw_mEnX7gKJTHek/s1600/Turkey+Employment.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 238px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYnTZP1DhH7L4KNm2zrnOV_Am4Z8rEAUnIncbusUlAKcP6RIZstLfaXxDG7fL_JsdhUljHRobwyFg7dQwjdVJtRkmV0A7Y8SliFWdDx8hnIt8ZebHsBs32U33MYxOWIw_mEnX7gKJTHek/s400/Turkey+Employment.png" alt="" id="BLOGGER_PHOTO_ID_5553602453211257746" border="0" /></a><br /><br />In its bid to achieve ultra-fast "catch-up" economic and employment growth without generating excessively high inflation Turkey is able to benefit from the phenomenon known as the “demographic dividend.” Cutting aside the rigmarole, what this idea basically implies is that as fertility falls ever higher proportions of the population are to be found in the working age category, initially boosting employment and output, and then, in a second wave, fuelling productivity, credit and consumption growth. This is what sets the Turkish case apart, for example, from the recent experiences in places like the Baltics and Bulgaria.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwbjt4pSubHQQrR9KhGXbB2r_OGZUuwoFVxArDPB0pt9Jg3rmRhhinwQuxw9NLHvl461nXZbMsEBAw-XTGNQzLyD57XcAwOkfnd1cVr-1oyQuRQTTs_8Pv1aOl5YkUBxaGq-uyYIVGiEA/s1600/Turkey+Labour+Force.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 234px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwbjt4pSubHQQrR9KhGXbB2r_OGZUuwoFVxArDPB0pt9Jg3rmRhhinwQuxw9NLHvl461nXZbMsEBAw-XTGNQzLyD57XcAwOkfnd1cVr-1oyQuRQTTs_8Pv1aOl5YkUBxaGq-uyYIVGiEA/s400/Turkey+Labour+Force.png" alt="" id="BLOGGER_PHOTO_ID_5553602794859452066" border="0" /></a><br /><br /><br />As the country's median age rises, Turkey is rapidly approaching that demographic “sweet spot” where sustainable rapid catch-up growth is totally realistic and achievable. However, it is important to bear in mind that this process is far from automatic, and depends for its effectiveness on continuing and deep structural reforms. The Turkish economy still fails to make satisfactory use of its existing labour resources, and the country’s employment rate, at just above 40%, remains the lowest in the OECD area. Deep-rooted socio-cultural factors, combined with the steady drift from rural to urban areas, mean that many Turkish women continue to withdraw from the labour force on marriage, which leaves the employment rate for women stuck around the 20% level, 40 percentage points lower than the equivalent rate for men.<br /><br />Turkey's population has been growing rapidly, and will continue to grow quite rapidly for at least the next two decades. This will mean there will be an internal market with a strong growth dynamic, and that the country faces a more stable population pyramid in terms of pension and health care systems, and sovereign debt sustainability. This outlook also implies improving credit ratings and lower risk evaluation on the part of investors, with consequently lower interest rates for investment projects.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjsdTVQ2-v2Ox_2XKfOXsePYObyrIe9wc1Igahby0lftSU3EcHhHw6AstnfJZ5H_yQxRrNuET0Csf3MMzOm6g2CWWcTA_nLfiECJrISez_DlZREvKcMcEEHAOMgAACeomw4og17JBGP9jA/s1600/Turkey+Population.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 202px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjsdTVQ2-v2Ox_2XKfOXsePYObyrIe9wc1Igahby0lftSU3EcHhHw6AstnfJZ5H_yQxRrNuET0Csf3MMzOm6g2CWWcTA_nLfiECJrISez_DlZREvKcMcEEHAOMgAACeomw4og17JBGP9jA/s400/Turkey+Population.png" alt="" id="BLOGGER_PHOTO_ID_5553603162809140578" border="0" /></a><br /><br />As I say, Turkey's median age is also rising, although the country is still very young, with a median age of just 28.5 and 30 per cent of the 74 million population under 18. The demographic "sweet spot" of median ages between 30 and 40 is thus set to last for some considerable period of time.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiDzKGdAsJOfWkuR-0j1yAoZpsUP08wXEEXQBJzW_c2vbT5ZHDogHvhACauczrfjL2t0l7LAWznjvBOnyyQoc0Th8AyrMIy6DmNw9njIeAXzY7NDw8QomxkOaGSZF6h6cJkfRDtYdpLLx0/s1600/Turkey+Median+Age.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 231px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiDzKGdAsJOfWkuR-0j1yAoZpsUP08wXEEXQBJzW_c2vbT5ZHDogHvhACauczrfjL2t0l7LAWznjvBOnyyQoc0Th8AyrMIy6DmNw9njIeAXzY7NDw8QomxkOaGSZF6h6cJkfRDtYdpLLx0/s400/Turkey+Median+Age.png" alt="" id="BLOGGER_PHOTO_ID_5553604196689656146" border="0" /></a><br /><br />Rising median ages, and growing proportions of the population in the working age group are a product of two distinct forces, declining fertility and rising life expectancy. Turkey's fertility has been falling steadily for the last thirty years, and is now around the critical 2.1 replacement level. The key driving force behind the change is female emancipation and rising education levels. The difficult thing for the country now will be to arrest the fertility decline and maintain the birth rate around the replacement level. Unfortunately, absent a serious and sustained change in the policy approach it is far more likely that Turkey will follow the pattern already seen in Southern and Eastern Europe, and head towards very low (and therefore unsustainable in the long run) fertility levels.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiDnorTJVbLF54fOZhS5wyt2PFifvPtTduDdkPIdJLKUuHcbjWR49-Fz9lWorrDaUmH-NcoV6aiViI0EcBMvAs0qnICeYN8jYv0NvpEOblDUvsHL_4R4FejWIbouL-kDVeEITQZkVG67kA/s1600/Turkey+TFR.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 200px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiDnorTJVbLF54fOZhS5wyt2PFifvPtTduDdkPIdJLKUuHcbjWR49-Fz9lWorrDaUmH-NcoV6aiViI0EcBMvAs0qnICeYN8jYv0NvpEOblDUvsHL_4R4FejWIbouL-kDVeEITQZkVG67kA/s400/Turkey+TFR.png" alt="" id="BLOGGER_PHOTO_ID_5553608611099642818" border="0" /></a><br /><span style="font-weight: bold;">Rapid Growth With Low Inflation?</span><br /><br />Given the controversial nature of the new monetary policy experiment, it is highly the country's inflation rate will come under increasing scrutiny. After keeping its benchmark interest rate unchanged at 7% since November 2009, the central bank has now lowered the rate to 6.5%, even as the economy continues to show signs of strong growth in credit driven consumer demand.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLKt7or-eFds-beqwnZ-MBdjWt4gJVycOMO6t-hsE_d7sj1ZX2m78X_p8tZdGhFUpiQVpqnu5tScWM8iXc1yHHZCaPz432l5zBVn2HppiqupuWzjkZHagA7JSAAch0yP5h1IwHUmwpMT4/s1600/Turkey+Interest+Rates.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLKt7or-eFds-beqwnZ-MBdjWt4gJVycOMO6t-hsE_d7sj1ZX2m78X_p8tZdGhFUpiQVpqnu5tScWM8iXc1yHHZCaPz432l5zBVn2HppiqupuWzjkZHagA7JSAAch0yP5h1IwHUmwpMT4/s400/Turkey+Interest+Rates.png" alt="" id="BLOGGER_PHOTO_ID_5553610502431531730" border="0" /></a><br /><br />The bank have justified their decision by highlighting the fact that core inflation rate is falling, and in fact came in under their year-end target for the first time since the central bank introduced an inflation targeting regime. They also strongly draw attention to the potential negative consequences of raising rates in an environment where this may only accelerate the inflow of short-term, speculative funding. Given that one of the key objectives of the central bank has to be reducing the level of interest rates in order to make it easier and more attractive to invest, the bank is likely to show great reluctance in moving towards monetary tightening and will most probably continue to rely on other tools to keep inflation in check, such as increasing reserve requirements to control credit growth.<br /><br />Since the start of the crisis the central bank have lowered rates 14 times from their October 2008 high of 16.75%. The Bank’s stated objective is to bring the level of interest rates permanently down to well below their long term historic levels. Their ability to do this, however, is conditional on their success in reducing the endemically high levels of inflation which have continually plagued the economy.<br /><br />Certainly Turkey’s inflation rate is now extremely low compared with levels considered typical only a decade ago, but it is still an upside outlier in comparison with regional peers, and in recent months it has been showing renewed signs of an uptick.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgFPP6GxpDXqPBwJrokKfg9bKDzRnEZJ-hUt8dnEHxzdjiK0nS9ly1V8g5pKsrvW-Cc5GnoQvydxdMMy0GjutFCFnZw8Y47IbcNZNZkGGHEg3qHJTwtjv87_iCerQ0xhafW4Hjp-UpViHU/s1600/Turkey+Inflation+Annual.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgFPP6GxpDXqPBwJrokKfg9bKDzRnEZJ-hUt8dnEHxzdjiK0nS9ly1V8g5pKsrvW-Cc5GnoQvydxdMMy0GjutFCFnZw8Y47IbcNZNZkGGHEg3qHJTwtjv87_iCerQ0xhafW4Hjp-UpViHU/s400/Turkey+Inflation+Annual.png" alt="" id="BLOGGER_PHOTO_ID_5556930569123702194" border="0" /></a><br /><br />Despite the country’s secular disinflationary tend, inflation has remained stubbornly high in recent months, although it did fall for the third consecutive month in December, registering a 12 month low of 6.4%, and down from the 9.3% seen in September. Nevertheles this level is still way too high for comfort, and especially in the context of an appreciating currency. The December inflation drop was largely due to a fall in volatile food prices, which were down 2.7% from November. The ex-fresh-food-and-energy core reading has been falling all year, and stood at 3.18% in December.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEighEVYqhcpXXD4UxiY3EZBGk7Zz89wDaeOd9IIo24CL6V0wFr7onIkQA9_a-rq3ExBdNwWIO1q9IoJHO0vJaayTq2WN2e_FxSb12QOpe6g19RVSkPwdX-uUXxQFx1HDhxkzzzoRYdcvEk/s1600/Turkey+HICP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEighEVYqhcpXXD4UxiY3EZBGk7Zz89wDaeOd9IIo24CL6V0wFr7onIkQA9_a-rq3ExBdNwWIO1q9IoJHO0vJaayTq2WN2e_FxSb12QOpe6g19RVSkPwdX-uUXxQFx1HDhxkzzzoRYdcvEk/s400/Turkey+HICP.png" alt="" id="BLOGGER_PHOTO_ID_5559806988128373538" border="0" /></a><br /><br />This core inflation is one of the central bank’s preferred measures of underlying inflation, so they will have drawn some comfort from downward rend, but they will also have noted that producer prices rose by an annual 7.73% in December (as compared with 4.16% in December 2009), a detail which may not alarm them at this point, but which will certainly give them food for thought if the rate remains high as 2011 advances.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgY79cz8VW5kzNqSSfs3ggq7dYEAaAZodWPnq8yOSTlPmEBsUNhkq37YUIY-dQR4QkTNJ9qDwxfgENyMwxPzm3InIwqWDb4-Ssw3Y34WuYt3x_Pr5DqHlUMT_g4zhTOvVWX40VUifI98Lo/s1600/Turkey+Core.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgY79cz8VW5kzNqSSfs3ggq7dYEAaAZodWPnq8yOSTlPmEBsUNhkq37YUIY-dQR4QkTNJ9qDwxfgENyMwxPzm3InIwqWDb4-Ssw3Y34WuYt3x_Pr5DqHlUMT_g4zhTOvVWX40VUifI98Lo/s400/Turkey+Core.png" alt="" id="BLOGGER_PHOTO_ID_5559806900036355970" border="0" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEis5Bt43YO3vXgSAxXqTiuatJSAJpq8bKVamL9sRUbVU5wKNJg2vreRF5ZJsLmYKCxUalzaZxIoCQKGnIR8w_wP_wprqdS6FTNfAhDe0AZ3l1DJdZPfICge7MFpR6NiQYpQorc6SA17TAo/s1600/Turkey+PPI+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 203px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEis5Bt43YO3vXgSAxXqTiuatJSAJpq8bKVamL9sRUbVU5wKNJg2vreRF5ZJsLmYKCxUalzaZxIoCQKGnIR8w_wP_wprqdS6FTNfAhDe0AZ3l1DJdZPfICge7MFpR6NiQYpQorc6SA17TAo/s400/Turkey+PPI+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5559807070266608786" border="0" /></a><br /><br /><span style="font-weight: bold;"><br />Public Indebtedness Is Not A Serious Problem</span><br /><br />After many years of extremely high government deficit, Turkey has been remarkably prudent since the turn of the century . The country’s fiscal deficit has remained low since the implementation of the IMF programme, and this despite the recent crisis-generated increase. As a result, with low deficits, strong growth and high inflation debt to GDP has fallen steadily (don't start letting your mouth water Greece, this combination is impossible in a currency union). Driven up by the recession, the deficit hit 5.6% of GDP in 2009, and according to IMF projections it is expected to fall back again to 3.4% in 2011. Gross debt peaked at 45.5% of GDP in 2009, and is in the process of falling back steadily, although we shoudn't get too excited about this, since it is what you should expect to see in a country with such a comparatively young population: real pressure on the sovereign will only start as and when the population median age rises to current EU levels .<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiDDe6Qq_K-0MHzG257LLmbdOU9xNAhdVooLsUWjUqwp9x7rfPP7sJ43fP7NIVkH6iyRsNGTPv5zet6T34oPUIDsonn203u3FSsCuPWg6f51x3Rip4cO8wqj5mOr2uq6OkMG1_azVql420/s1600/Turkey+Gross+Government+Debt.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 230px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiDDe6Qq_K-0MHzG257LLmbdOU9xNAhdVooLsUWjUqwp9x7rfPP7sJ43fP7NIVkH6iyRsNGTPv5zet6T34oPUIDsonn203u3FSsCuPWg6f51x3Rip4cO8wqj5mOr2uq6OkMG1_azVql420/s400/Turkey+Gross+Government+Debt.png" alt="" id="BLOGGER_PHOTO_ID_5556932860154795218" border="0" /></a><br /><br /><br />So there is little room for complacency. The recent decision by the Turkish government to shelve the proposed Fiscal Rule legislation (a measure which would have permenently committed the government to target a 1% fiscal deficit) has come in for a lot of criticism, most notably from the IMF. But caution is called for here, since the decision most likely reflects the government’s concern not to prematurely tie its hands in the face of what might be a quite closely contested election in 2011. So a wait and see attitude might be more appropriate before passing any kind of definitive judgement.<br /><br />Certainly the data we have to date show quite a strong fiscal performance throughout 2010, with the government posted a primary budget surplus of TRY4.6 billion in November compared with a TRY1.2 billion deficit in the same period of 2009. Central government revenues rose by an impressive 42.4% YoY in November, while expenditures rose by 22.9%. In fact November’s results bring the year-to-date general budget deficit to TRY23.5bn – almost half of the budget deficit in January-November 2009 – and the primary surplus to TRY 23bn (Jan-Nov 2009: TRY 5.8bn), which means last years budget deficit may well come in at under the EU limit of 3%, and will in any event be significantly below the government target of 4% So despite credibility slippage, in the short term the strong economic expansion may well assuage concerns about longer term sustainability. What really matters is what happens this year, and in the years which follow. The government has budgeted for a 2.8% fiscal deficit in 2011, and given the credibility issues involved I wouldn't be surprised to see them keep to this, despite the coming election.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwetuqUqj7wkZDMPUvsnWrqFjsX1EXpB_cqU9auoOmxDBTuvlokfjlziprWYpF03FzxnkUhOiIWVz4f1tvhCW1JaeM7mM1YPbZ-Ho2E4-JAj7ZUTH6YZOiWWe89ESdMHkkQLj3ONdmPfg/s1600/Turkey+Fiscal+Deficit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 251px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwetuqUqj7wkZDMPUvsnWrqFjsX1EXpB_cqU9auoOmxDBTuvlokfjlziprWYpF03FzxnkUhOiIWVz4f1tvhCW1JaeM7mM1YPbZ-Ho2E4-JAj7ZUTH6YZOiWWe89ESdMHkkQLj3ONdmPfg/s400/Turkey+Fiscal+Deficit.png" alt="" id="BLOGGER_PHOTO_ID_5556934906923518642" border="0" /></a><br /><br />However, in taking what seems to be the easier path now and postponing the watertight commitment to fiscal stability for some moment in the future, the government may be storing up trouble for itself or its successor. Spending excess tax revenues is only stimulating an economy which is not in need of stimulation, whereas saving them would not only be building a cushion for the future, it would also help reduce pressure on the current account deficit by draining some demand from the economy.<br /><br /><span style="font-weight: bold;">Private Sector Debt Not A Problem At This Point Either</span><br /><br /><br />Nor is the level of private sector debt a problem, since even though it has been rising rapidly of late, the level (at around 35% of GDP) is still quite low, and relatively sustainable for a rapidly developing country.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEicgoQB8ECdFI7dWcxtq_3GDAoMv1qrJKHV-YQ9OCHU3PL3Jx-tAoQSUFz9n_xKnLsXVUVW76kkJDXHd-oh6KjlW5UJ2Zk6iWbIqWTdVd1QFmlckmtijXrxyxpI36NAYnSQaKFQYGTBSP8/s1600/Turkey+Total+Private+Sector+Credit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 236px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEicgoQB8ECdFI7dWcxtq_3GDAoMv1qrJKHV-YQ9OCHU3PL3Jx-tAoQSUFz9n_xKnLsXVUVW76kkJDXHd-oh6KjlW5UJ2Zk6iWbIqWTdVd1QFmlckmtijXrxyxpI36NAYnSQaKFQYGTBSP8/s400/Turkey+Total+Private+Sector+Credit.png" alt="" id="BLOGGER_PHOTO_ID_5556938807854655074" border="0" /></a><br /><br />Household debt which has been rising at rates close to 40% this year should be brought under greater control, since while current levels are not worrysome, letting these growth rates continue is not desireable.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgdnRmP43rnNqHZAAbooOyXP-zIxJQ51rCTTibYPAHUHQ1k1eJXUKO7eyVb-NJjc3Cd5JxjtAcSX6MW1NXGmLvXIYj2vSyGtEWjxfqWgLsS_lcmfh31tBiEL10euih483z5boQf84h0SXA/s1600/Turkey+Total+Credit+To+Households+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 218px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgdnRmP43rnNqHZAAbooOyXP-zIxJQ51rCTTibYPAHUHQ1k1eJXUKO7eyVb-NJjc3Cd5JxjtAcSX6MW1NXGmLvXIYj2vSyGtEWjxfqWgLsS_lcmfh31tBiEL10euih483z5boQf84h0SXA/s400/Turkey+Total+Credit+To+Households+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5556938696513894770" border="0" /></a><br /><br />The same goes for housing loans. The current boom in construction activity and household mortgage lending is fine, but it does need to be kept in check.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiD6sYG-rLDd3DWA6QaPjJKHXRFuH_wkwLM-6k5v68ppLgOQl8Rr2AIfuHREcp0hijXU51ho5Kg0WxnkalpZcnNNDrdYNuLM3qmNeNr_BbfqhiSCErvENvWoPu8w53-aYSeAjHvmaMd2I8/s1600/Turkey+Total+Housing+Loans+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiD6sYG-rLDd3DWA6QaPjJKHXRFuH_wkwLM-6k5v68ppLgOQl8Rr2AIfuHREcp0hijXU51ho5Kg0WxnkalpZcnNNDrdYNuLM3qmNeNr_BbfqhiSCErvENvWoPu8w53-aYSeAjHvmaMd2I8/s400/Turkey+Total+Housing+Loans+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5556938575733124194" border="0" /></a><br /><br /><br /><span style="font-weight: bold;">Outlook: Steady Growth, Falling Long Term Interest Rates and A Round Of Credit Rating Upgrades</span><br /><br />So 2011 looks like it will be a pretty good year for Turkey. Of course, not everyone is convinced by the new monetary policy initiative, and <a href="http://www.imf.org/external/np/ms/2010/121710.htm">the IMF have been quick to warn of the dangers</a>. In particular they warn about the continuing practice of unsterilsed purchasing of foreign currencies. The answer here is not too difficult: sterilise, that is withdraw liquidity to compensate, which is what the bank seems intent on doing via the increase reuqired reserves.<br /><br />However the IMF also warned of the danger that, even if sterilised, large purchases by the central bank could become unsustainable, given the aggressive nature of the liquidity withdrawals which would be required to maintain the stance. Undeterred by the davice, on 21st December 21st Bank Governor Durmus Yilmaz announced that the Bank was not only set on continuing its policy of carrying out forex purchases, it was actually going to increase them, taking the amount of its daily foreign-exchange purchases (as of January 3rd 2011) from US$40m to US$50m. It is quite possible the IMF have a serious point here, and the bank may do well to consider more actively their proposal that the Bank apply the increased reserve requirements on both TRY and forex denominated accounts, and that they also extend coverage of the requirements to other credit providers and instruments in an attempt to rebalance the maturity profile of their borrowing, ie reduce their dependence on short term borrowing.<br /><br /><br /><br />On the other hand, while one EU sovereign after another finds itself facing ever increasing borrowing costs, the process in Turkey moving in the opposite direction. Just last week Turkish bond yields extended a record low, registering their steepest two-day decline in almost eight months on speculation inflation will continue to slow, thus allowing the central bank to cut its interest rates even further. The Turkish lira depreciated to its weakest levl in six months last week, touching 1.5683 per dollar at one point last Friday. The yield on the benchmark two-year lira bond closed the week at 6.98 percent after the two-year debt yield fell below 7 percent for the first time ever on Wednesday.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhe473f-xMR6f9pZTa0_zyl0wYJkrTntfl5JVvCLKHu3mz4Dz23b-F_32UpQBtBMolOra_OHqStQJjc_z17uW6kzvOGmLqNm4wAiNsN6T2bWm-NDZqVDzypoBMZB8kU4Nf1FWDDA60YH_A/s1600/Turkey+2+year+yield+two.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 292px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhe473f-xMR6f9pZTa0_zyl0wYJkrTntfl5JVvCLKHu3mz4Dz23b-F_32UpQBtBMolOra_OHqStQJjc_z17uW6kzvOGmLqNm4wAiNsN6T2bWm-NDZqVDzypoBMZB8kU4Nf1FWDDA60YH_A/s400/Turkey+2+year+yield+two.png" alt="" id="BLOGGER_PHOTO_ID_5559825340663337762" border="0" /></a><br /><br />So far, then the policy is working, even if it is early days yet. Lower bond yields may also be favoured by forthcoming credit <span style="font-weight: bold;">upgrades</span>. Fitch Executive Edward Parker stated last month that while the Central Bank faced many challenges in 2011, Turkey’s sovereign credit rating would be positively affected if the new policy proves successful. Fitch currently has a local and foreign-currency bond rating for Turkey of BB+, one level below investment grade.<br /><br />He also noted that Turkey’s sovereign rating would be positively affected if Turkey’s debt to GDP ratio continued to decline and if there were no change in political stability following the general elections. In effect it is not likely that Turkey will become an investment grade country until after the June general elections since the rating agencies will want to see the results of the revised monetary policy stance, the fiscal performance ahead of the general elections and the political landscape following them before making this kind of rating upgrade. That being said, it is perfectly possible that both Moody’s and S&P's (which currently rate Turkey at Ba2 and BB, respectively, that is more than one notch below investment grade) could make an initial upgrade in Turkey’s sovereign rating (by one notch say) even before the general elections are held.<br /><br />The outlook for Turkey is thus extremely positive, even if there are concerns about the short term bias in bank funding, and longer term worries about structural distortions from the current account deficit. On the fiscal side the government is likely to have reduced the budget deficit to below 4% of gross domestic product in 2009 from 5.5% in 2009, and is quite likely to fulfil its targe of 2.8% this year, making it one of the very few countries in the EU orbit to come in with a deficit within the 3% official target level. So while there are no guarantees that the latest initiative from the Central Bank will work, there are grounds for hope and expectation that both they and the government will make changes and search for solutions even if they don't.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-90771624729153139772011-01-04T13:24:00.001-08:002011-01-05T00:13:52.784-08:00The Verdict on US Bond Yields?<p>By Claus Vistesen: Hull<br /></p><p><br /></p><p>Just before we turned the clock on 2010 <a href="http://clausvistesen.squarespace.com/alphasources-blog/2010/12/20/rising-us-bond-yields.html">I commented</a> on the recent increase in US yields and noted the following simple issue;</p> <blockquote> <p>How investors perceive and interpret this will [rising yields] determine great many things; is it a reflection of higher growth in the future and thus a sooner than expected normalisation by the Fed. Or is it a result of supply concerns and the continuing double digit budget deficit by the Fed and thus the bond vigilantes attempt to go for the biggest prey in the park.</p> </blockquote> <p>Obviously, interpretation, animal spirits and sunspots can never be entirely disconnected from real economic activity on the ground, but the underlying point is important.</p> <p>If rising yields are seen as a reflection of growing concerns over the US authorities' ability and willingness to control to the deficit it could hamper ability to maneuver for the Fed and the Treasury. If on the other rising yields are seen as a reflection of policy makers' success in reviving back growth through QE and an extension of tax cuts, it goes together with an altogether more benign narrative about how the deficit will pay for itself as higher growth leads to higher income and more leeway in managing public finances.</p> <p>So which is it?</p> <p>Well, <a href="http://www.bloomberg.com/news/2011-01-03/vigilantes-sidelined-as-growth-tops-deficit-among-treasury-swap-investors.html">a recent piece by Bloomberg's Daniel Krueger</a> suggests that the latter discourse is emerging and thus that whoever playing the part as bond vigilante these days, he or she has failed in their attempt to drive the conversation (so far).</p> <blockquote> <p><em>Quote Bloomberg</em></p> <p>The worst performance by Treasuries since the second quarter of 2009 reflects prospects for faster U.S. economic growth rather than concern that rising budget deficits will drive investors away from government debt.</p> <p>(...)</p> <p>Even as deficits remain at almost record highs, the bond market is giving the U.S. time to address structural budget imbalances. A Bloomberg News survey of the 18 bond dealers that serve as counterparties to the Federal Reserve in its open market transactions show they forecast the 10-year Treasury yield to rise to 3.65 percent from 3.30 percent on Dec. 31, below its average of 4.33 percent since 2000. Two-year yields will climb to 1.05 percent from 0.59 percent, holding below the average of 3.03 percent since the beginning of 2000.</p> <p>(...)</p> <p>“The market is starting to believe the Fed will be successful in creating growth,” said Ray Humphrey, who manages inflation-indexed bond portfolios in Hartford, Connecticut for Hartford Investment Management Co., which has $161.7 billion in assets. “Nominal bonds are frankly reflecting those higher growth rates.”</p> </blockquote> <p>This is interesting for a host of reasons. First of all, with an estimated budget deficit of 10-11% of GDP in 2011, it seems that the old adage that the US economy <em>is</em> indeed different still holds true. Consequently, and <a href="http://www.businessinsider.com/category/muni-bonds">local government debt/muni ghosts</a> notwithstanding it appears the US economy is getting all the leash other economies in the OECD are not.</p> <p>Looking at the charts, I would not hold it against you if you thought that this was much ado about nothing though.</p> <p><em>(click for larger image)</em></p> <p><span class="full-image-block ssNonEditable"><span> </span></span></p> <p style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjhWePBm2tpvmS5qPaakb9Y1Hr5lS_Q7eJSKWvnVqKe9js_khhmyOse2LfykhgVNsk9LI3Q1HQ9CtG_DBoLjGcvNGCQB2YSIDZpIYoHRnVBVksj7bblCt3uiJUr35KJuXLdxkWiV-y1lt7L/s1600/US+Yields.JPG"><img src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjhWePBm2tpvmS5qPaakb9Y1Hr5lS_Q7eJSKWvnVqKe9js_khhmyOse2LfykhgVNsk9LI3Q1HQ9CtG_DBoLjGcvNGCQB2YSIDZpIYoHRnVBVksj7bblCt3uiJUr35KJuXLdxkWiV-y1lt7L/s320/US+Yields.JPG?__SQUARESPACE_CACHEVERSION=1294175092250" alt="" /></a></p> <p>In general, the US yield curve has steepened considerably since the infamous March-09 low in risky assets mainly as a result of the fact that although short term yields have been kept tightly in check by the Fed's policies, yields on longer dated bonds slowly crept upward in 2009 with both the 10y2y and 20y2y increasing notably. This in turn, albeit with a lag, has sparked comment from both Fed officials and prominent analysts that the Fed would use additional QE measures to massage the long end of the yield curve especially as it is the long end which determines the rate on mortgages which is a gauge strongly watched by the Fed.</p> <p>In 2010 and much contrary to the talk about rising yields; both long term and short term yields have actually declined on the year. From December to January it is pretty much status quo on the yield curve measured by the 2y10y though with 2 year nominal yield declining 31.3 basis points and 10 year nominal yields declining 44 basis points.</p> <p>The action and talk on rising yields come from the fact that in Q4 yields have increased across the board with longer dated bonds taking the worst hit as the curve steepened across all spreads. 10 year yields rose the most from October to December rising 75 basis points while 2 year yields increased by a mere 24 basis points in comparison. As such, what turned out to be a good year for bond investors has turned sour right at the end.</p> <p>The real important thing going forward is how long US policy makers can benefit from the win-win discourse of rising yields and a strenghtening economy. One would be tempted to say that if only the Fed came out openly and targeted a level of the SP500 then the world would be much more transparent. What I am basically saying is that one key part of the Fed's current policies is the explicit targeting of equity prices and the subsequent positive wealth effect perceived as well as real.</p> <p>Fundamentally, it is bit of tighthrope walk since the main condition for the good days to continue is a very fine balance epitomized by the notion of a "mild-goldilocks" scenario. In short, yields can go up as long as they want except if it translates into the <em>actual expectation</em> of an interest rate hike by the Fed. As such, the economy should continue growing but not so strong as to force the Fed's hand into a more hawkish discourse.</p>CVhttp://www.blogger.com/profile/16843402165210120665noreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-89888854991951477702010-11-29T09:51:00.000-08:002010-11-29T11:08:24.194-08:00Another Lesson In How Not To Go About Things From The EU Commissionby Edward Hugh: Barcelona<br /><br />The present generation of European leaders will doubtless be remembered for many things, but somewhere high up there on the list will be the appauling sense of bad-timing they seem to have when making critical announcements. The confusion caused by certain ill-considered remarks from Angela Merkel about how private sectors bondholders would need to participate in future EU bailout processes is evidently one good example. Another, without doubt is going to be the decision by EU Commissioner Olli Rehn to appear before the world's press today (yes, today of all days, one day after the sensitive announcement of the Irish Bank Bail-out plan and the decision to create the European Financial Mechanism), and inform the assembled throngs that as far as the EU Commission could see Spain will not be sticking to its 6% of GDP fiscal deficit committment next year, simply because according to EU calculations the deficit is going to be 6.4% - unless, of course - there is another round of fiscal reduction measures.<br /><br />I think Spanish has a suitable word for this kind of persistent badtiming: "gafé". But the thing is, if Europe's leaders insist on continually showing the markets just how "gafé" they all are, then we are never going to find our way out of this hole we have all dug for ourselves. <br /><br />And so it was, that by 16:30 this afternoon the yield on 10 year Spanish bonds hit 5.5% (up from around 5.2 at Friday's close), and the spread over equivalent German Bunds hit a Euro-era record high of 273 basis points. These sort of numbers were totally unimaginable at the start of 2010.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEisEYoVJzfaF9Nr_08rk1Cmg0ZV9nS38ptCgJ5mmFGiQsgbXcNAyeFY9YDnHucRhvGcRRRbeH3zrdPOhM9eOJwIF2hctwf1N0r-byFVYhW_tpdYB0pbo_3la-u1ZquZcDvgMlK5xuqeFyU/s1600/Spain+BondYield.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 195px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEisEYoVJzfaF9Nr_08rk1Cmg0ZV9nS38ptCgJ5mmFGiQsgbXcNAyeFY9YDnHucRhvGcRRRbeH3zrdPOhM9eOJwIF2hctwf1N0r-byFVYhW_tpdYB0pbo_3la-u1ZquZcDvgMlK5xuqeFyU/s400/Spain+BondYield.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5545050054810371618" /></a><br /><br />The root of the problem comes from the fact that the EU Commission had identified today as the day when their economic forecasts for national economies were to be published, and so it was. As part of the forecast the commission fractionally lowered its 2011 growth outlook for Spain, to 0.7% from an earlier expectation of 0.8%. Hardly earth-shattering news, and not normally the sort of thing to send bond yields off into a "death spiral", but given the times we live in, markets are extraordinarily sensitive to any such revision. In fact, a downward revision of 0.1 percentage point is well within the bounds of any reasonable margin of error, and no one really has the foggiest idea of what Spanish growth will actually look like next year beyond the most approximate of approximate guesses. This is because the degree of uncertainty is unusually high in the external environment, and the impact of the very strong fiscal correction that is planned (from this years 9.2% deficit, to next years 6% one) is very hard to evaluate. Personally I think it will be very hard for Spain to get positive GDP growth at all next year given all we are seeing, but I certainly don't want to engage in a Dutch auction with the Spanish authorities on this point.<br /><br />But in fact the potential difficulties for Spain to achieve the 6% target for 2011 were already reasonably well known. <a href="http://spaineconomy.blogspot.com/2010/09/is-6-percent-2011-deficit-realistically.html">I had already written about it in this post</a>, were I pointed out the difficulty Spain's regional and local governments were having this year in meeting targets, and how important it was going to be to stick by the letter of next years budget plan if the administration did not wish to face the wrath of the markets.<br /><br />My points were backed up the day after by Bank of Spain Governor Miguel Angel Fernandez Ordonez, who told a Spanish parliamentary committee that:<br /><br />“Recent budget data point to the achievement of objectives for 2010, at least for the central government.... but (as far as the regional governments go) my impression is that the measures [they've announced] are far from sufficient”<br /><br />The Bank of Spain governor reinforced this point by adding that in a highly decentralized Spain, where the central government directly controls less than a third of spending, and lacks sufficient means to supervise the fiscal policies of regional and local administrations, it was extremely difficult for the central government to get an exact result. His opinion was that these august bodies be required to publish budget data in a more timely fashion and be given an annual spending ceiling. In fact, these days the Spanish government cannot afford to ignore what the Governor of its Central Bank says, and so the administration has gone some way to putting such controls in place, but whether they are sufficient to do the job or not still remains to be seen.<br /><br />Mafo's point was backed up later the same week by former Bank of Spain deputy governor and current IMF Official José Viñals, who stated "Spain should be willing to carry out additional fiscal adjustments to achieve a budget deficit of 6 percent of gross domestic product by 2011 because markets have “zero tolerance” for failure to meet stated targets."<br /><br />So these issues are already known, Spain may well need to formulate a plan "B" if the governments hand is forced, but it was a pity to unsettle the markets just one more time by raising them again precisely today.<br /><br />Not everything in the report was bad news for Spain, however, since the commission did improve its forecast for this year. The EU now expects the country's GDP to contract by 0.2% in 2010, compared with the 0.4% contraction it had projected in the spring forecast, giving a little more power to the elbow of a struggling Elena Salgado who has recently been belabouring the point that her forecasts are better than those of the EU and the IMF. But next year will be the "test of fire" on this front, since it is starting next year that all those rather optimistic expectations on domestic consumption start to lock-in.<br /><br />Having said that, the EU now predicts that annual average unemployment will rise again next year, and hit 20.2% (above Salgado's forcecast). In fact this may well be an underestimate, since the September figure was 20.8%, and at the present time unemployment is still rising, and not falling. Indeed Olli Rehn himself stressed that there were "significant but balanced risks to the baseline scenario." And in particular he pointed out that further drops in house prices could lead to a "deeper-than-expected adjustment in construction, dent household wealth and sap consumer confidence." And yet that is just what Spain seems to continue to be facing, a slow drop-by-drop downward trickle in house prices.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0UvO3ymkr6HuGcCm686rIUUe-begdWEap8mSx0Zhi7iRA3laW7-iXSZuYTjd_6x7bldFTPtxuHBw4bHfkgBkcj8wYUMJthOsWUXCIVOQNWV0dQ_ZaB1RXf_S2Ossno-PCd4NSnQl9_IM/s1600/tinsa+one.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 241px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0UvO3ymkr6HuGcCm686rIUUe-begdWEap8mSx0Zhi7iRA3laW7-iXSZuYTjd_6x7bldFTPtxuHBw4bHfkgBkcj8wYUMJthOsWUXCIVOQNWV0dQ_ZaB1RXf_S2Ossno-PCd4NSnQl9_IM/s400/tinsa+one.png" alt="" id="BLOGGER_PHOTO_ID_5545016269807842482" border="0" /></a><br /><br />So what can the Spanish government do to stop the rot? Basically at this point very little. The ammunition has nearly all been fired off, and most of it has been wasted. And yet one more time we all seem to be in agreement. When asked what Spain and Portugal should do to stop the so-called contagion, I was quoted by the Financial Times as saying: “Not do anything wrong..... The only thing you can advise these people to do at this stage is to be absolutely frank and stick absolutely to what they say.” “From this point on, the more you do fiscal austerity, the more you contract and the less you can pay".<br /><br />The following day Manuel Campa, Spain's deputy finance minister for the economy was quoted by Bloomberg in a similar vein as saying that the best thing “to generate credibility in the Spanish economy is to execute the measures we have announced at the time and in the way they were announced, and that implies not taking additional measures.”<br /><br />And as luck would have it Miguel Angel Fernandez Ordonez was back before the Spanish senate the following day (his timing, unlike that of Olli Rehn, seems to be impeccable), telling all those senators that “We have to convince people that we’re going to do exactly what we said we were going to do.” Seems logical, doesn't it, I mean whyever would they imagine you might not do what you say you are going to do? Whatever put that wicked thought in their heads?<br /><br />And Mafo was also on this occasion perfectly frank about the growth situation: "The outlook for a gradual recovery is surrounded by uncertainties," he told the senators."In an environment where financing conditions will foreseeably remain restrictive and in which the public and the private sector have a pressing need to clean up their financial position, we can expect the pace of recovery in household consumption to slow versus the first half of the year."<br /><br />I couldn't have put it better myself.<br /><br />So, summing up. Spain is suffering from the serious restrictions imposed on trying to make a major economic correction while participating in a monetary union (<a href="http://www.nytimes.com/2010/11/29/opinion/29krugman.html?_r=1&partner=rssnyt&emc=rss">Paul Krugman is once more making similar points in today's New York Times</a>). In particular this means that not only does the country not have a currency to devalue, it does not have a central bank with capacity to print money and buy its bonds. It also has a very substantial exposure in terms of the external position (ie debt) that makes it dependent on international financial markets for funding in a way that means that the extremely low interest rates that are on offer at the ECB are not really (beyond some limited non standard liquidity measures) passed on to the countries banks, her citizens, her companies or her government.<br /><br />Spain has the benefits of neither expansionary fiscal or monetary tools in the midst of a huge output slump, where the underlying contractionary tendencies in the economy are still substantial. Given all of this, and given that Spain's leaders have at last shown some signs that they are aware of the seriousness of the situation that faces the country, I think it is being cruel beyond belief to haggle over whether the deficit next year will be 6% or 6.4%, let alone send Spanish bond values into a suicidal downward spiral that risks destroying what is still left of the countries banks over the issue.<br /><br />Spain needs to stick to its deficit reduction targets, but it also needs more help from those who are running the system by which it is trapped and which it is struggling hard to defend. Pile the pressure on and the country is only going to crack. What Spain needs is to get back to growth, and to put people back to work, then the deficit problems will sort themselves out almost on their own. And in this sense it is the authors of the latest EU forecast, and not those who run the Spanish administration who are the unrealistic ones. Spain is in a corner which it can't get out of alone. She needs help, and that help is going to have to come from the top.<br /><br />As Krugman says:<br /><br /><blockquote> If Spain still had its own currency, like the United States — or like Britain, which shares some of the same characteristics — it could have let that currency fall, making its industry competitive again. But with Spain on the euro, that option isn’t available. Instead, Spain must achieve “internal devaluation”: it must cut wages and prices until its costs are back in line with its neighbors.<br /><br />And internal devaluation is an ugly affair. For one thing, it’s slow: it normally take years of high unemployment to push wages down. Beyond that, falling wages mean falling incomes, while debt stays the same. So internal devaluation worsens the private sector’s debt problems.</blockquote><br /><br />Internal devaluation is coming, there is now no avoiding it. When I advanced the idea for Spain some three years ago it wasn't some sort of contribution to a collective brainstorming session, it wasn't just one option on offer together with a whole series of others. What I was saying was if we don't go down this path then would would inevitably end up where we are now. But as Krugman points out, seeing it through means the private sector debt problem will only deteriorate, which is why we need help, to share the burden. The other alternative, of seeing the Euro fall apart, is in the interests of no one. Not even the Germans, who would soon see the current record growth in their exports shifted into reverse gear as the new DeutscheMark was quoted at values (as is happening to the Japanese yen right now) which robbed the country of all semblance of competitiveness.<br /><br />Well, today we have a new government in Catalonia. So maybe its time to change. Maybe finally we could now start to address the problems of the Spanish economy head-on, and put the future of the country on a sound and sustainable footing. It's certainly worth a try, and, at least, as the English saying goes: where there's life, there's hope.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-41172578892622612462010-11-29T09:49:00.000-08:002010-11-29T09:51:03.823-08:00Greece Is Almost Certainly "On Track" - But Towards Which Destination Is It Headed?by Edward Hugh: Barcelona<br /><br />"There is a difficulty that is widely recognized that the amount [of debt] to be repaid is high in 2014 and 2015," Giorgios Papaconstantinou (the Greek Finance Minister).<br /><br />"We are confident that Greece will be able to return to the markets. But whether it will be able to return to the markets on a scale that allows Greece to pay off its European partners and the IMF, that is a question."..."We have a number of options. If paying off the €110 billion loan proves to be a question, we stand ready to exercise some of those options" - Poul Thomsen, head of the IMF team in the ECB-EU-IMF troika delegation.<br /><br />"In the rushed last-minute deal to forestall certain bankruptcy, everyone missed one very important fact. That the memorandum created an unrealistic and immense borrowing squeeze on the feckless Greek state for the next five years."<br />Nick Skrekas - Refusing Greek Loan Extensions Defies Financial Reality, Wall Street Journal<br /><br /><strong>Get On The Right Track Baby!</strong><br /><br />According to the latest IMF-EU report Greece’s reform programme remians “broadly on track” even if the international lenders do acknowledge that this years fiscal deficit target will now not be met and that a fresh round of structural measures is needed if the country is to generate a sustained recovery. My difficulty here must be with my understanding of the English lexemes "remains" and "sustainable", since for something to remain on track it should have been running along it previously (rather than never having gotten on it), and for something - in this case a recovery - to be sustained, it first needs to get started, and with an economy looking set to contract by nearly 4% this year, and the IMF forecasting a further shrinkage of 2.6% next year, many Greeks could be forgiven for thinking that talk of recovery at this point is, at the very least, premature. A more useful question might be "what kind of medicine is this that we are being given", and "what are the realistic chances that it actually works". Unfortunately, in the weird and wonderful world of Macro Economics, witch doctors are not in short supply.<br /><br />As the representatives of the so-called `troika`mission (the IMF, the ECB, and the EU) told the assembled journalists in last Tuesday's press conference “The programme has reached a critical juncture." Critical certainly (as in, in danger of going critical - just look at the 1,000 basis point spread between Greek and German 10 year bond yields, or the 4% contraction in GDP we look set to see this year), but the question we might really like to ask ourselves is what are the chances of the patient surviving the operation in one piece?<br /><br />The statement came at the end of a 10-day mission visit to Athens to review the extent to which the country was complying with the terms of the country’s €110bn bail-out package and take a decision on whether or not to authorise the release of the third tranche of the agreed loan.<br /><br />In the event the decision was a foregone conclusion, with the rekindling of the European Sovereign Debt Crisis as a background, and the very survival of the common currency in the longer term in question, this was no time to tell the markets the tranche was not being forwarded. But still, the expression "on track" continues to fall somewhat short of expectation with the lingered issues like the recent upward revision of the Greek deficit numbers (up to 15.4% for 2009), the failure to increase revenue as much as anticipated, and the need for a further round of “belt tightening” measures in 2011 to try to attain the agreed objective of a 7.4% deficit as a backdrop. The upward revision in the deficit numbers only added to all the doubts many economists have about the long term payability of the Greek debt, which the IMF now expect to peak at around 145% of GDP in 2013, although again, many analysts put the number much higher.<br /><br />Independent analyst Philip Ammerman who is based in Greece, and whose expectations about the evolution of Greek debt have proved to be reasonably realistic, <a href="http://www.philip-atticus.com/2010/11/return-of-bond-vigilantes-and-financial.html">now expects debt to GDP to come in much higher than anticipated in 2010</a>, due largely to 10 billion euros in debt from the train company OSE being added to the total and downward revisions in 2009 GDP from the Greek statistics office.<br /><br />The key to payability is of course a resumption of economic growth, which at the present time looks even more distant than ever. The IMF is arguing for another round of structural reforms – like opening up “closed-shop” professions, or simplifying administrative procedures and modernising collective wage bargaining, and while many of these are necessary, none of these are sufficiently “short sharp shock” like to restart the economy, and in general don’t target the main issue which is how to restore competitiveness to the country’s struggling export sector.<br /><br /><strong>Just One More Moment In Time!</strong><br /><br />Doubts about how Greece was going to start financing its debts in the market after the expiry of the loan programme in 2013 had only been adding to market nervousness in recent days, since in addition to the fact that loan repayments to the EU and the IMF would need to start in 2014. Most critical are the first two years, when the bulk of the debt to the EU and IMF falls due. Under current repayment schedules, In fact, as things stand now, Greece's gross borrowing needs for 2014 and 2015 (when most of the EU-IMF debt falls due) will balloon to over 70 billion euros a year from around 55 billion euros a year in 2011-2013. This represents having to finance about 40% of GDP each year. Not an easy task. The difficulty presented by this looming repayment mountain lead the FT’s John Dizard to speculate that the Greek parliament might be tempted to go for the rapid passage of a law allowing for the application of “aggregate collective action” on bondholders – using the reasoning that, since the money being borrowed at the moment is basically being used to pay off existing bondholders (who are relatively easy to haircut) while the new lenders (the IMF and the EU) are (at least on paper) not. As John says, “Greece is exchanging outstanding debt that is legally and logistically easy to restructure on favourable terms with debt that is difficult or impossible to restructure. It’s as if they were borrowing from a Mafia loan shark to repay an advance from their grandmother”.<br /><br />What a (retroactive) aggregate collective action clause would mean is that if a specific fraction, say 80 per cent or 90 per cent, of existing Greek bondholders agree to a restructuring that lowers the net present value of Greek debt by, say, half, then the remaining “holdout” bondholders would be forced into accepting the same terms. It is the consideration that the Greek Parliament might be tempted to go down just such a road that possibly lies <a href="http://uk.reuters.com/article/idUKTRE6AQ1LR20101127">behind this weekends Reuters report</a> that The EU and the IMF could extend the period in which Greece must repay its bailout loans by five years, to make it easier for it to service its debt. According hot the agency Poul Thomsen, the IMF official in charge of the Greek bailout, stated in an interview with the Greek newspaper Realnews "We have the possibility to extend the repayment period ... from about six years to around 11," This follows earlier reported statements from Mr Thomsen the the IMF “could provide part of the funding on a longer repayment period, or give a follow-up loan.” Indeed the announcement of the Irish Bailout details seems to suggest there has been a general change of position here, since the Irish loan is initially to be for seven and a half years (which certainly does suggest we are all trying hard to kick the can further and further down the road), while - in what you might think was a token nod in the direction of John Dizard's argument, aggregate collective action clauses are now to be written into all bond agreements after 2013. It will be interesting to see how the existing bondholders themselves respond to this proposal when the markets open tomorrow (Monday) morning.<br /><br />So now we know that in fact Greece is likely to be able to extend its dependence on the IMF all the way through to 2020, the only really major question facing us all is: just how small will the Greek economy have become by the time we reach that point.<br /><br />To start to answer that question, let’s take a look at some of the macro economic realities which lie behind the “impressive start” the Mr Thomsen tells us the Greek economy has made.<br /><br /><strong>Austerity Measures Provoke Sharp Economic Contraction</strong><br /><br />The IMF-EU-ECB austerity measures have - predictably - generated a sharp contraction in Greek GDP, with falling industrial output, falling investment, falling incomes, falling retail sales, and rising inflation and unemployment. The big issue dividing Macro Economists at this point is whether countries forming part of a currency union which have a competitiveness problem are best served by their fiscal difficulties being addressed first.<br /><br />Arguably countries which do not have the luxury of implementing a swift and decisive devaluation to restore their competitiveness would be best served by receiving fiscal support from other part of the monetary unionion to soften the blow as they implement a comprehensive programme of internal devaluation to reduce their price and wage levels. That is to say the current approach has the issue back to front, and will undoubtedly lead the countries concerned into even more problems as slashing government spending at a time when no other sector is able to grow is only likely to create a vicious spiral which leads nowhere except towards eventual and inevitable default. To date Greek GDP has fallen some 6.8% from its highest point in Q1 2008, yet far from bottoming out, the contraction seems to be accelerating under the hammer blows of ever stronger fiscal adjustments, and the downard slump still has a long way to go.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYW8tmg9l1ndSTXDBU0l_6xRe7CamvEIZ2jlvIcw4pSemh59EROy2oU826KNWnMoN9CwCSHmUAyXdjPf6yuu2cc-TZDNfs17l9jdtx5S1PYdnQljktAVIaeeA2G_DSF5R84ODtN71T9FU/s1600/Greek+GDP+Constant+Prices.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYW8tmg9l1ndSTXDBU0l_6xRe7CamvEIZ2jlvIcw4pSemh59EROy2oU826KNWnMoN9CwCSHmUAyXdjPf6yuu2cc-TZDNfs17l9jdtx5S1PYdnQljktAVIaeeA2G_DSF5R84ODtN71T9FU/s400/Greek+GDP+Constant+Prices.png" alt="" id="BLOGGER_PHOTO_ID_5544678335935228658" border="0" /></a><br /><br />The Greek economy contracted by 1.1% quarter-on-quarter in the third quarter of 2010, making for the eighth consecutive quarter of contraction. And evidently there are still have several more quarters of GDP contraction lying out there in front of us.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhv8ExYCmT0kkaFiYWRaSRsbLCssKZO6tPxUMxotwIRbZOd285L1dyA9ETSC60OB6KVBhxBJ1pG_bCAqWVzYzlrrQJ4sL4S63FWrlRQR7da13ViedNJtRLvksmK07dA5Nk1PEROGZpB5-Q/s1600/Greece+Q-o-Q.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhv8ExYCmT0kkaFiYWRaSRsbLCssKZO6tPxUMxotwIRbZOd285L1dyA9ETSC60OB6KVBhxBJ1pG_bCAqWVzYzlrrQJ4sL4S63FWrlRQR7da13ViedNJtRLvksmK07dA5Nk1PEROGZpB5-Q/s400/Greece+Q-o-Q.png" alt="" id="BLOGGER_PHOTO_ID_5544680785375978674" border="0" /></a><br /><br />Year on year the Greek economy was down by 4.5% on the third quarter of 2009. This is the fastest rate of interannual contraction so far. Far from slowing the contraction seems to be accelerating at this point.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhk-jpFKPlstovGU_02ctyagoVHs9L23Js9JxmgHFIsbd8RXLaj7nglB5fSmvzUweEHF-NaVmpbsyaLYH8DsXBG7WPaU6zjcqR-6dN32gyfrPc2kju-KI4fB7f1JLTC0NcvYGi1XgVIPsA/s1600/Greece+GDP+YoY.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhk-jpFKPlstovGU_02ctyagoVHs9L23Js9JxmgHFIsbd8RXLaj7nglB5fSmvzUweEHF-NaVmpbsyaLYH8DsXBG7WPaU6zjcqR-6dN32gyfrPc2kju-KI4fB7f1JLTC0NcvYGi1XgVIPsA/s400/Greece+GDP+YoY.png" alt="" id="BLOGGER_PHOTO_ID_5544681289425090834" border="0" /></a><br /><br /><br /><strong>Domestic Consumption In Full Retreat</strong><br /><br /><br />Looking at the chart below, it is clear that Greece enjoyed quite a consumption boom in the first years of the Euro's existence, a boom which is in some ways reminiscent of those other booms in Ireland and Spain, and a boom which came roundly to an end when the credit markets started to shut down. As in other countries, the government stepped in with borrowing to try to keep the boom going, with the major difference that deficitfinance went to levels well beyond those seen in other European countries in 2009, as did the efforts the Greek government went to to try to cover its tracks.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnuPhU4_pavyPmvJSZ8r00hpLFZvDhbAzsb882uz_y9jcHXGJKj2tOX0fh8NVdhLezQpxJTsf-hhZXzGcOxNdVRwtSWwac4IdtcZVDN5ey82poDUv9Y24MNkjWmu2rKM3FUC1FUAL8ymY/s1600/Greece+Private+Consumption+Volume.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 224px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnuPhU4_pavyPmvJSZ8r00hpLFZvDhbAzsb882uz_y9jcHXGJKj2tOX0fh8NVdhLezQpxJTsf-hhZXzGcOxNdVRwtSWwac4IdtcZVDN5ey82poDUv9Y24MNkjWmu2rKM3FUC1FUAL8ymY/s400/Greece+Private+Consumption+Volume.png" alt="" id="BLOGGER_PHOTO_ID_5544683396679037234" border="0" /></a><br /><br />One of the clearest indications that the party is now well and truly over is the way in which the level of new car registrations is slumping.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhWWZQeA3fAQop77mT11EEwI9acD6ybQs0QozhloSnBvKHEkPD3rhP92BK7ChlHdP_QbEQwbg7MelRnKf9E8Ph7dQyLZc-GGFyTWzdUsPPGKHBPF9_wNxEco5PtMt08yvT80Lpl39OLdWY/s1600/Greece+car+registrations.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 245px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhWWZQeA3fAQop77mT11EEwI9acD6ybQs0QozhloSnBvKHEkPD3rhP92BK7ChlHdP_QbEQwbg7MelRnKf9E8Ph7dQyLZc-GGFyTWzdUsPPGKHBPF9_wNxEco5PtMt08yvT80Lpl39OLdWY/s400/Greece+car+registrations.png" alt="" id="BLOGGER_PHOTO_ID_5544684641473197282" border="0" /></a><br /><br />Retail sales have now fallen by something over 15%.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhUCFe9Hkc6wk9hGy1-mbgFN1IMVzxJh8nVa2X4334ZVZM0n_DSXS5bLvqaymYKmxTW4iFvYz0YO-3XBEZBSOzmG_fkSejDlsCXppmR-HTX5NHZCftmZJ_oI8AD_MRgm1tjzf5W2rpLOKY/s1600/Greece+retail+sales.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhUCFe9Hkc6wk9hGy1-mbgFN1IMVzxJh8nVa2X4334ZVZM0n_DSXS5bLvqaymYKmxTW4iFvYz0YO-3XBEZBSOzmG_fkSejDlsCXppmR-HTX5NHZCftmZJ_oI8AD_MRgm1tjzf5W2rpLOKY/s400/Greece+retail+sales.png" alt="" id="BLOGGER_PHOTO_ID_5544704385026931794" border="0" /></a><br /><br /><br /><strong>And With It The End Of The Credit Boom</strong><br /><br />The Greek consumption boom came to an end, just as it did in Spain and Ireland, when the credit crunch started to bite in 2008. Pre-crisis household borrowing was increasing at the rate of around 20%, the interannual rate of change has now fallen more or less to zero, and will stay there for some time to come. Since in a mature modern economy aggregate demand (whatever you do in the way of supply side reforms) can only grow in a sustained way as a result of either credit expansion or exports, export growth is going to have to give the Greek economy what little demand growth it can eventually get.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9ZN_uEYhyu3WAxbwYVvfE4tAeEypX7l6dCaobL7WnB8KyrxFdOC3qCBGwC8iaI0bnx8e-2FPMHHpEIaoa9kb4-AtPe3EAmhnYtVK4t2ukLew283M7MMqBQ5FBpN4ly1C9kC4RhSzdN0Y/s1600/Greece+Bank+Lending+To+Households.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9ZN_uEYhyu3WAxbwYVvfE4tAeEypX7l6dCaobL7WnB8KyrxFdOC3qCBGwC8iaI0bnx8e-2FPMHHpEIaoa9kb4-AtPe3EAmhnYtVK4t2ukLew283M7MMqBQ5FBpN4ly1C9kC4RhSzdN0Y/s400/Greece+Bank+Lending+To+Households.png" alt="" id="BLOGGER_PHOTO_ID_5544704670182330306" border="0" /></a><br /><br />Along with the general stagnation in household credit, lending for mortgage borrowing has also ground to a sharp halt.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiMfcd-WnFPbjDycwZbJUGn3taAlMe7OLlJ-ZDYxLUAZo_k27lJvpm7Z_kRPHknA-Xw4MUIuYPrDDCpXwTyw90v4F_6jwNeTGHf8RB-ilznmSq7UzlofVNzPBk9aHoVOev3oAvWCyct9fQ/s1600/Greece+Bank+Lending+For+House+Purchases.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiMfcd-WnFPbjDycwZbJUGn3taAlMe7OLlJ-ZDYxLUAZo_k27lJvpm7Z_kRPHknA-Xw4MUIuYPrDDCpXwTyw90v4F_6jwNeTGHf8RB-ilznmSq7UzlofVNzPBk9aHoVOev3oAvWCyct9fQ/s400/Greece+Bank+Lending+For+House+Purchases.png" alt="" id="BLOGGER_PHOTO_ID_5544705994968668930" border="0" /></a><br /><br />And credit to companies has also become pretty tight if we look at the next chart.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTCvn8rOdthPZ9z-R5jDyChg92tj9o2CA9dfvahjv5mCv0-b8Jhp35xWVbLADHwiubEdaQbzdU-yIpwMoyFacH8HGXIBSbQMAPteNGaZqceOUbpvEIo965VzvGmKDcCmshyphenhyphenHbfgu9kziU/s1600/Greece+Bank+Lending+to+Corporates.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTCvn8rOdthPZ9z-R5jDyChg92tj9o2CA9dfvahjv5mCv0-b8Jhp35xWVbLADHwiubEdaQbzdU-yIpwMoyFacH8HGXIBSbQMAPteNGaZqceOUbpvEIo965VzvGmKDcCmshyphenhyphenHbfgu9kziU/s400/Greece+Bank+Lending+to+Corporates.png" alt="" id="BLOGGER_PHOTO_ID_5544718496639146338" border="0" /></a><br /><br />Asin many other heavily indebted countries (the US, the UK, Spain) the only sector which is still able to leverage itself is the public one, or at least which was still able to drive demand by leveraging itself, but now, with the IMF EU adjustment programme, increases in government borrowing are also going to suddenly come to an end, with the evident consequencethat the economy goes into reverse gear. I can't help feeling that people aren't using enough emotional intelligence here. Obviously people are outraged by the level of fiscal fraud that was going on in Greece. But outrage and demogogic press headlines seldom form the basis of sound policy. Arguably the competitiveness issue is more important at this point than the fiscal deficit one, since the position is asymmetric - solving the competitiveness issue will automatically open the door to solving the fiscal deficit one, while addressing the fiscal deficit does not necessarily resolve the competitiveness problem, and does not return the country to growth - only a strong supply side dose of ideology can lead you to (mistakenly) think that.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0qOnVORjEJrAQfpDMtu_LBhLOwLWPSd_S9kcW8lUQps066oIu_thnX4x2UTWN6OiOrNe65wNO4gBAv8Jed42F06cIFCj8z-S-3Z2pPLMyC3yNBJwL246Et1aoP65Nx4KLrQoemYsLzA0/s1600/Greece+Bank+lending+to+government.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0qOnVORjEJrAQfpDMtu_LBhLOwLWPSd_S9kcW8lUQps066oIu_thnX4x2UTWN6OiOrNe65wNO4gBAv8Jed42F06cIFCj8z-S-3Z2pPLMyC3yNBJwL246Et1aoP65Nx4KLrQoemYsLzA0/s400/Greece+Bank+lending+to+government.png" alt="" id="BLOGGER_PHOTO_ID_5544718706531654962" border="0" /></a><br /><br /><strong>The Best Way Not To Restore Competitiveness: Raise VAT</strong><br /><br /><br />In fact, the fiscal adjustment programme contains two components, reducing spending, and increasing taxes. Of these the most damaging measure as far as growth and competitiveness goes is without doubt the decision to raise VAT by 5%. Not only (as we shall see) does this increase not raise the extra money anticipated (in an economy which is increasingly export dependent the tax base for a consumption tax weakens by-the-quarter in relative terms), it also sharply raises the domestic inflation rate, effectively ADDING to the competitiveness problem. I would say this obsession of the IMF with raising VAT in these economies which are effectively unable to devalue is just plain daft, frankly. And it doesn't impress me how many times respected micro economists describe raising VAT as the most benign of measures: all this does is convince me that they don't really have an adequate understanding of how economies work from a macro point of view, and especially not export dependent economies.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEic255npI153CbdPfk2BzVc47pD3OMQsSOnK4yLJEziWqqCuCZu7bfaVdz0uhBqt_Yw7ycZUaEYdW84Vtd1pHV509xsC9qN9n56R2OOrjn-hgLQahNk_UNaExGr_YlC7NtyXJWIkitQJZQ/s1600/CPI+YoY.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 215px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEic255npI153CbdPfk2BzVc47pD3OMQsSOnK4yLJEziWqqCuCZu7bfaVdz0uhBqt_Yw7ycZUaEYdW84Vtd1pHV509xsC9qN9n56R2OOrjn-hgLQahNk_UNaExGr_YlC7NtyXJWIkitQJZQ/s400/CPI+YoY.png" alt="" id="BLOGGER_PHOTO_ID_5544720200422583378" border="0" /></a><br /><br />As we can see in the chart below, the VAT rise not only adds to the consumer price index, it also affects producer prices, and even export sector producer prices, which are sharply up.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0PUesXPonv4Ch5lOCTXZcTx2gB7gTew6H-iCksMIyDCnk4nZ2p6PsOsTBYJF27-ddjMYB2e3nDDqirqPxa3krKUpUgoomXtMVUsXkqL-7xKRBZX3YKmj35_WxbpMnW47LKDu-ciAdOZQ/s1600/Greece+Export+Producer+Prices.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 218px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0PUesXPonv4Ch5lOCTXZcTx2gB7gTew6H-iCksMIyDCnk4nZ2p6PsOsTBYJF27-ddjMYB2e3nDDqirqPxa3krKUpUgoomXtMVUsXkqL-7xKRBZX3YKmj35_WxbpMnW47LKDu-ciAdOZQ/s400/Greece+Export+Producer+Prices.png" alt="" id="BLOGGER_PHOTO_ID_5544721585398101938" border="0" /></a><br /><br />I would say that policymakers have fallen into two "Econ 101 simpleton" type errors here. The first is to think that since part of the objective is to raise nominal GDP to reduce debt to GDP, and since GDP is falling, raising the price level might help (I would call this the "fools gold" discovery), and the second is to imagine that since exports don't attract VAT, the impact is relatively benign, without stopping to think the the VAT hike also acts on inputs, and especially in an economy which suffers from chronic price and wage rigidity issues like the Greek one.<br /><br />If a first year student had sent me these kind of arguments in a term essay, aside form awarding a "fail", I think would recommend to the person that they would perhaps be better off studying another topic, physics maybe, since the demonstrated aptitude for applied macro economics would be very low indeed. Could it be that bondholders who normally understand quite a lot more than many imagine about how economies work are also noticing this, hence their growing nervousness.<br /><br />The incredible result of the application of this very short sighted policy is that in addition to the fact that Greece started out with a serious competitiveness issue with its most competitive EuroArea peers, like Germany.....<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg_TjEMBkHpwyt90Xoi-wNVsn5fzv3htD8YZM3c5gUIxeG0QTbku3DHJ6TQFljUoSydenxDzZlqZZKgsG1ZhsWebs5tj1V3HbkMB_oAgA2_hiNs94sWKHxYJEZlwWwCJtJ9Wtq7NzIqWfI/s1600/Greece+and+Germany+REER.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg_TjEMBkHpwyt90Xoi-wNVsn5fzv3htD8YZM3c5gUIxeG0QTbku3DHJ6TQFljUoSydenxDzZlqZZKgsG1ZhsWebs5tj1V3HbkMB_oAgA2_hiNs94sWKHxYJEZlwWwCJtJ9Wtq7NzIqWfI/s400/Greece+and+Germany+REER.png" alt="" id="BLOGGER_PHOTO_ID_5544725901858640738" border="0" /></a><br /><br />it has even hadits virtual currency revalued against the EuroArea average since entering the IMF sponsored programme, which is the exact opposite of what we need to see.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiVtfcRWICPYKZKIgwTnwW_eYNXV2rHrtr6TBqJSsCXCd2XPpy0tj2pyK0zPDJaPZdfJljRxpmLdmU-VI0koUmFurS28fEdqtuLHSf2Q3ETgVBEehsVbO8Yw7RmD0hDP-HYZ-l_60N5wEc/s1600/Greece+REER+Quarterly.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiVtfcRWICPYKZKIgwTnwW_eYNXV2rHrtr6TBqJSsCXCd2XPpy0tj2pyK0zPDJaPZdfJljRxpmLdmU-VI0koUmFurS28fEdqtuLHSf2Q3ETgVBEehsVbO8Yw7RmD0hDP-HYZ-l_60N5wEc/s400/Greece+REER+Quarterly.png" alt="" id="BLOGGER_PHOTO_ID_5544726236425444242" border="0" /></a><br /><br /><br /><strong>Export Lethargy Feeds The Industrial Output Slump</strong><br /><br />As a result we are seeing no evidence of a Germany-type resurgence in export activity.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhr7qzwCaytK0RKK6qopy1f7hWIiN3IWYFXviQhQvKwNCAOhqoGXMEX9OiiBNY_T4ij8utcA83PieTac2YiKcxjr0G3pdA0E0218lh9444tpacHxfDeRPFKXLP7gvBFOzO4pWPG1qew1_c/s1600/Greece+Exports.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 225px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhr7qzwCaytK0RKK6qopy1f7hWIiN3IWYFXviQhQvKwNCAOhqoGXMEX9OiiBNY_T4ij8utcA83PieTac2YiKcxjr0G3pdA0E0218lh9444tpacHxfDeRPFKXLP7gvBFOzO4pWPG1qew1_c/s400/Greece+Exports.png" alt="" id="BLOGGER_PHOTO_ID_5544726433263690194" border="0" /></a><br /><br />And in fact even though the trade deficit has reduced somewhat, it still remains a trade deficit.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjd6uJWZPECSKwyC3xYMeXoMYMPAm96ScexvLAAP98orJKnR4kHmtjm1-A257CyLXsDTk_7lWanUTcy420QCDZfyhbKQthIiBeIwjdwdwa6S0luTPhZvV_5CsuXyo-kmVrKPB8odA17Q84/s1600/Greece+Trade+Deficit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjd6uJWZPECSKwyC3xYMeXoMYMPAm96ScexvLAAP98orJKnR4kHmtjm1-A257CyLXsDTk_7lWanUTcy420QCDZfyhbKQthIiBeIwjdwdwa6S0luTPhZvV_5CsuXyo-kmVrKPB8odA17Q84/s400/Greece+Trade+Deficit.png" alt="" id="BLOGGER_PHOTO_ID_5544726702204392146" border="0" /></a><br /><br />Given the fact that domestic demand is falling, while exports stagnate, Greece's industrial sector is still in a sharp and continuing contraction.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiP5WxgPV_YUBszNUpVYayoSW3SOu2NmFojePYJ6cbctE6x0PO6QKHOG85mWe9kSglM0N8CcJbACDc0jrDXm3saUlfPJo2HaWnuzxCgiwUbdMp_rMHoiNclk74YA1lCRAp9kxzuds5UJiQ/s1600/Greece+Industrial+Output.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 234px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiP5WxgPV_YUBszNUpVYayoSW3SOu2NmFojePYJ6cbctE6x0PO6QKHOG85mWe9kSglM0N8CcJbACDc0jrDXm3saUlfPJo2HaWnuzxCgiwUbdMp_rMHoiNclk74YA1lCRAp9kxzuds5UJiQ/s400/Greece+Industrial+Output.png" alt="" id="BLOGGER_PHOTO_ID_5544726981237665458" border="0" /></a><br /><br />A contraction which continued and even accelerated slightly in October, according to the most recent PMI reading.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhGLSbsMkg4QR9dwZ5tRPc2hyphenhyphenaYmBlQe-x1Uht_F3eyn73U3XspafvgFWyr5t4PK0MZyots_YCFKW0tp8v9EQYKw0zxckfRIvatOUgJKnr5m87izNPpAAsfKPq6ddiY03JcZ7HlalJIAj8/s1600/Greece.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhGLSbsMkg4QR9dwZ5tRPc2hyphenhyphenaYmBlQe-x1Uht_F3eyn73U3XspafvgFWyr5t4PK0MZyots_YCFKW0tp8v9EQYKw0zxckfRIvatOUgJKnr5m87izNPpAAsfKPq6ddiY03JcZ7HlalJIAj8/s400/Greece.png" alt="" id="BLOGGER_PHOTO_ID_5544727210231710754" border="0" /></a><br /><br />Construction activity is in "freefall", as can be seen from the drop in cement output.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjIP9bU1fuF5zmY6mj69WoQyfegP84lTGr57k8LSEyU1O6PcEoFDop-LIji22RYaWsSWJpNAVTVfByDu4Rev_ooU6J7iwGmaZrEepBJ8dGIqnfftsHuBnAD5oHqph72p1TwDe4b-wtHPP0/s1600/Greece+Cement+Output.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 223px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjIP9bU1fuF5zmY6mj69WoQyfegP84lTGr57k8LSEyU1O6PcEoFDop-LIji22RYaWsSWJpNAVTVfByDu4Rev_ooU6J7iwGmaZrEepBJ8dGIqnfftsHuBnAD5oHqph72p1TwDe4b-wtHPP0/s400/Greece+Cement+Output.png" alt="" id="BLOGGER_PHOTO_ID_5544727476851733410" border="0" /></a><br /><br />and the decline will surely continue, as new building permits continue to fall.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgUEJkJ9SHZ_F1zlkm2hvUhWrbiDcCcJvAem4InnBWgS4qmvGjZ4KohjpZdsUBI7rcoiWU7RoJtwsxjB0mYLSRZbqNd8mozyBYj7GSP5q6Qi8iWnfhZO-_RBS0Zmhy445A9w1TP4RG1Vuk/s1600/Greece+Building+Permits.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 244px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgUEJkJ9SHZ_F1zlkm2hvUhWrbiDcCcJvAem4InnBWgS4qmvGjZ4KohjpZdsUBI7rcoiWU7RoJtwsxjB0mYLSRZbqNd8mozyBYj7GSP5q6Qi8iWnfhZO-_RBS0Zmhy445A9w1TP4RG1Vuk/s400/Greece+Building+Permits.png" alt="" id="BLOGGER_PHOTO_ID_5544727766146151298" border="0" /></a><br /><br />And private construction activity continues to drop.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjbpfJgIDFNg0g68N1Dv5hgvtGIv1pYE5qhexrvfhMdYy_sFwd8isYZ-basDBIWRmlYbOlK1ihN1rfq5p9aKE-VcVU5q33GicEfgnQKftKnipiXCf5Qb0v1ASr_J_45CZ85QpEbJ-yLo0E/s1600/Greece+Private+Construction+Output.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 253px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjbpfJgIDFNg0g68N1Dv5hgvtGIv1pYE5qhexrvfhMdYy_sFwd8isYZ-basDBIWRmlYbOlK1ihN1rfq5p9aKE-VcVU5q33GicEfgnQKftKnipiXCf5Qb0v1ASr_J_45CZ85QpEbJ-yLo0E/s400/Greece+Private+Construction+Output.png" alt="" id="BLOGGER_PHOTO_ID_5544728010084982562" border="0" /></a><br /><br /><br />The net result of the economic contraction and a credit crunch is, of course, that while other consumer prices rise, house prices are now falling, giving us just one more reason why Greeks are starting to feel a lot less wealthy than they used to feel. Evidently, to kick start the economy again the fall in land and property prices needs to be brought to a halt. This is where the traditional devaluation strategy helped a lot, since you could stop the fall in nominal prices at a stroke, but the Greeks are helpless in this case, and it is rather alarming to find that there is no discussion of this key issue at the policy level, and just talk about how structural reforms will put everything right.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEip9kGtGM6D611Y4VooOp_ImFQrjeYSn2ctG2qRubq3UdFWXwhyphenhyphenE-t3qaeh3FUH-HJPvs0AMvPyoioWdVChEJmcFh5A-1ptwF2D427Fz6-mhEtUVK8Tin6x0h4_N3XMGRdrmDoR-gfEoSU/s1600/Greece+House+Price+Index.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEip9kGtGM6D611Y4VooOp_ImFQrjeYSn2ctG2qRubq3UdFWXwhyphenhyphenE-t3qaeh3FUH-HJPvs0AMvPyoioWdVChEJmcFh5A-1ptwF2D427Fz6-mhEtUVK8Tin6x0h4_N3XMGRdrmDoR-gfEoSU/s400/Greece+House+Price+Index.png" alt="" id="BLOGGER_PHOTO_ID_5544728288754199954" border="0" /></a><br /><br /><br /><strong>Employment Falls And Unemployment Surges</strong><br /><br />The man and woman power is there to rebuild the economy, as ageing hasn't yet reached the point where the labour force will start to shrink. Indeed at this point it is still rising.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj9UOZWGpXrqgfxBfP_zCD8OfNQ9rWC_V3ZnYenjxZJEY91w1dGEJ45-EEyVA7TyzxHcJEty8ySPwisbDVm4pQMdj7w2mn13Y9XfHHqhXxe6K-PrCoM0aQCA8ccthsLee6IsfuOIz9VS1c/s1600/Greece+Labour+Force.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj9UOZWGpXrqgfxBfP_zCD8OfNQ9rWC_V3ZnYenjxZJEY91w1dGEJ45-EEyVA7TyzxHcJEty8ySPwisbDVm4pQMdj7w2mn13Y9XfHHqhXxe6K-PrCoM0aQCA8ccthsLee6IsfuOIz9VS1c/s400/Greece+Labour+Force.png" alt="" id="BLOGGER_PHOTO_ID_5544729409252427906" border="0" /></a><br /><br />But, of course, employment is now falling.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhrOA8rS4wBFpEIqiDyOtFmc4UuNb3Sn7J1OkCbGIanH86mAPZ4Ja6di6aNXtLc9FlL21HiW3o1HGpxUjaDcjzWpaMoz79Rl45a0VrVL0ewsmzj6fStfplcLA3sWC_dk3DbdjV3e1FwgVk/s1600/Greece+Total+Employed.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 218px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhrOA8rS4wBFpEIqiDyOtFmc4UuNb3Sn7J1OkCbGIanH86mAPZ4Ja6di6aNXtLc9FlL21HiW3o1HGpxUjaDcjzWpaMoz79Rl45a0VrVL0ewsmzj6fStfplcLA3sWC_dk3DbdjV3e1FwgVk/s400/Greece+Total+Employed.png" alt="" id="BLOGGER_PHOTO_ID_5544729688834707074" border="0" /></a><br /><br />And thus, logically, unemployment is rising, and is currently something over 12%.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgj3ckKXWwpBAxA0ajZrLdYS8AxKy5u_cIzzQ5DpuEtwClwEbQ0WF2gK8oe6a3AOnBI9Lbyg4DbR6DffeJZYkV82w94RhZUioOKzoEhyphenhyphenk-NCje9_yn0EiC7-2n2f1Krb-JNafbqRzGM0b0/s1600/Greece+Unemployment.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgj3ckKXWwpBAxA0ajZrLdYS8AxKy5u_cIzzQ5DpuEtwClwEbQ0WF2gK8oe6a3AOnBI9Lbyg4DbR6DffeJZYkV82w94RhZUioOKzoEhyphenhyphenk-NCje9_yn0EiC7-2n2f1Krb-JNafbqRzGM0b0/s400/Greece+Unemployment.png" alt="" id="BLOGGER_PHOTO_ID_5544729908547363346" border="0" /></a><br /><br /><strong>And With The Fall In Employment Revenue Comes Under Pressure</strong><br /><br />And with the rise in unemployment, there is a fall in incomes, and thus income tax revenue is falling, putting yet more pressure on the deficit.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEge1LPqk0GWKzcZILAlqeIQpxfNl163knHqV0vbBYp3QdyhKIrGnvR8lBsbfmXJlSNTaroz8OUa06kQ_OvDs4sbpyzq085xCz9MC9TuqsGEma-q0-CrtRvyglZ01Oct-Jst1r8LzL8v8i8/s1600/Greece+Personal+Income+Tax+Revenues.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 218px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEge1LPqk0GWKzcZILAlqeIQpxfNl163knHqV0vbBYp3QdyhKIrGnvR8lBsbfmXJlSNTaroz8OUa06kQ_OvDs4sbpyzq085xCz9MC9TuqsGEma-q0-CrtRvyglZ01Oct-Jst1r8LzL8v8i8/s400/Greece+Personal+Income+Tax+Revenues.png" alt="" id="BLOGGER_PHOTO_ID_5544730438090989698" border="0" /></a><br /><br />At the same time, and despite a 5% increase in VAT rates, returns on the tax are also not rising as hoped.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjp5D_wLIucbmI4Y4_7JMWmzcbma_xdvyM1fG5oTelMM6rYfJyw-cJsnWHyiKocGRHSYLqRNyh15r-4ALcz8vS4hRGqJxYISX3uznpWeu3kKPFwia26BktZWXgkIuXIBa-q9gK0f5DXqdE/s1600/greece+VAT+returns.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjp5D_wLIucbmI4Y4_7JMWmzcbma_xdvyM1fG5oTelMM6rYfJyw-cJsnWHyiKocGRHSYLqRNyh15r-4ALcz8vS4hRGqJxYISX3uznpWeu3kKPFwia26BktZWXgkIuXIBa-q9gK0f5DXqdE/s400/greece+VAT+returns.png" alt="" id="BLOGGER_PHOTO_ID_5544730692625080130" border="0" /></a><br /><br /><br /><strong>A Contraction Which Feeds On Itself? </strong><br /><br />The Greek fiscal deficit is now falling, but after the huge upward revision in the 2009 figure, getting it down towards this years 9.4% target is a more or less Herculean task, which will involve far more fiscal effort than was previously anticipated, and with the fiscal effort more economic contraction. In addition, the finance ministry recently reported that while Greece's central-government deficit narrowed by 30% in the first 10 months of this year, this still fell short of the targeted narrowing of 32% due to lower than anticipated revenue returns.<br /><br />Finance ministry data show that the Greek central government took in 41.0 billion euros in revenue in the first 10 months of 2010, just 3.7% more than it did in the same period of 2009. The deficit-reduction plan hammered out with the EU and the IMF in May called for 13.7% growth in such revenues for 2010 as a whole. This implies that to meet the target, Greece must receive 14.1 euros billion in November and December, which is highly improbable given that to date this year the Greek government has only once had monthly revenue above €5 billion, and that was in January.<br /><br />On the spending side things have gone better, and targets are being met. Indeed over the summer the Greek government put forward a revised plan that compensates for the lower revenue with deeper spending cuts. But even meeting the lowered target of €52.7 billion would require a 30% jump over last year's revenue for the last two months of the year, and this is well nigh impossible.<br /><br />As a result of the revenue shortfalls and the revision in the 2009 deficit, Greece still looks to be well short of the 7.8% of GDP deficit originally aimed for. Current estimates are for a shortfall this year of something like 9.4% of GDP. In order to try to soothe market fears in this unsettled environment the Greek government last week unveiled a further austerity plan for 2011 involving an addition 5 billion euros in cuts, with the objective of cutting public deficit to 7.4% of GDP by the end of next year. Apart from the fiscal effort involved the new budget will almost certainly involve a stronger economic contraction than previously anticipated - and indeed the Greek government have already revised their forecast to 3% from the previous expectation of a 2.6% shrinkage.<br /><br />The problem is, that Greece is in danger of a counterproductive downward spiral here, since the revenue shortfall is at least partially the result of the existing budget austerity, which has simply helped to squeeze an already weak economy. The expected sharp contractions in GDP this year and next, will weighing heavily on revenue from income and sales taxes. Cuts to public-sector paychecks that went into affect this summer, for instance, have certainly helped contribute to a fall of about 10% in retail sales in August and September, and continuing unemployment rising above 12% will only add to the banking sectors bad debt problems.<br /><br /><br /><strong>You Need To Attack The Competitiveness Issue, And Not Just The Fiscal Deficit One</strong><br /><br />In my opinion the IMF are making a fundamental mistake in relying almost exclusively on structural reforms. "It has to come through structural reforms," Mr. Thomsen said, adding that he expected those reforms to be discussed at the next visit by the delegation early next year. "It cannot come through higher tax rates, that's not good for the economy, and it cannot come from more wage cuts because that is not fair."<br /><br />The are right that more taxes and less salaries without corresponding price reductions don't solve the problem, but Greece needs to do something radical (like a sharp internal devaluation) to restore competitiveness rapidly. Pushing the issues out to 2020 is no solution, and it is hard to imagine Greek civil society will accept the levels of unemployment and social dislocation that are being produced for such a lengthy period of time.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjN1FWQW2BolBLAcLJx7GRF4sW90op4_Y5ralgDtQV-dJGqF0or76rSo7daTSCg986ECGlZuPTmaeMoNe4qqI3JNMlqNWEDWz-jBH173ZhcAl3KewJ7NAM04pCKxuS76SmSGPvYjrfFOTg/s1600/Greece+Fiscal+Deficit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 205px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjN1FWQW2BolBLAcLJx7GRF4sW90op4_Y5ralgDtQV-dJGqF0or76rSo7daTSCg986ECGlZuPTmaeMoNe4qqI3JNMlqNWEDWz-jBH173ZhcAl3KewJ7NAM04pCKxuS76SmSGPvYjrfFOTg/s400/Greece+Fiscal+Deficit.png" alt="" id="BLOGGER_PHOTO_ID_5544730914777754530" border="0" /></a><br /><br />Estimates of the future path of Greek debt vary a lot, and their is considerable uncertainty involved in any estimate. The IMF currently forecast that the debt will peak at just under 145% of GDP in 2013, but I think we can regard that as an estimate at the lower end of the range.<br /><br />Despite the fact that George Papandreou's government has been widely praised for enforcing draconian austerity measures, the country still has the largest debt-to-GDP ratio in the EU, which involves a debt mountain of something like 330 billion euros - only 110 billion of which will be funded by the EU-IMF rescue programme. That is to say, private sector bondholders will still have something like (at least) 220 billion euros of exposure to Greek debt come 2013.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhrZ3jAHk9n-8qh1e4Bu0xXCAVlNoX5HASWwU5jqjhg5Q2OMZ3v06BAR4qp-6ppJrKZXlUsxvSCJ-YmXlMfleFjYxy5QXGIlJ_EYyHSTX5RSBohQXfSFuepG-ADeW5Z76J30CxBDJl6qgI/s1600/Greece+debt+to+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 207px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhrZ3jAHk9n-8qh1e4Bu0xXCAVlNoX5HASWwU5jqjhg5Q2OMZ3v06BAR4qp-6ppJrKZXlUsxvSCJ-YmXlMfleFjYxy5QXGIlJ_EYyHSTX5RSBohQXfSFuepG-ADeW5Z76J30CxBDJl6qgI/s400/Greece+debt+to+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5544731182534448530" border="0" /></a><br /><br />Greece's whopping current account deficit has reduced to some extent since the 2008 15% of GDP high, but the level is still quite large.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwMucsKt4pbCH3HJt8hJP7W-zTKAm5gYy12_5TZzKaiPTYY9DirMINrSZF8zocf55-aQTpRODlGf5EPAZYRgKj8-VMCe5ApGk9iAwx5QRWYL74QIKaaPjYxx1oqBh2KQtmIMRwFUcYnFo/s1600/Greece+current+account+monthly.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwMucsKt4pbCH3HJt8hJP7W-zTKAm5gYy12_5TZzKaiPTYY9DirMINrSZF8zocf55-aQTpRODlGf5EPAZYRgKj8-VMCe5ApGk9iAwx5QRWYL74QIKaaPjYxx1oqBh2KQtmIMRwFUcYnFo/s400/Greece+current+account+monthly.png" alt="" id="BLOGGER_PHOTO_ID_5544731408566187282" border="0" /></a><br /><br />More importantly the IMF do not forsee Greece running a current account surplus at least before 2015. Indeed they imagine that Greece will still have a current account deficit of 4% of GDP come 2015. Which means that far from paying down their external debt, Greek indebtedness (absent restructuring) will continue to rise over the whole period. According to Greek central bank data, the country had a net external investment position of 199 billion euros in 2009, or put another way, net external debt was something like 110% of GDP.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnQdn6p3Ktw6le7Ow5Ymc3ihAg1xjwy1uz4s9IcCe0Q1N47GjCmukfIHDNmn8hR1mHbctWmIJCWsgFw35cOw0pyBL-uGDNXH2QFjjGVASOGsYsHDSdzVAcMPlwgg4KwXagOTIxW8F5g5Y/s1600/Greece+Current+Account+Deficit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnQdn6p3Ktw6le7Ow5Ymc3ihAg1xjwy1uz4s9IcCe0Q1N47GjCmukfIHDNmn8hR1mHbctWmIJCWsgFw35cOw0pyBL-uGDNXH2QFjjGVASOGsYsHDSdzVAcMPlwgg4KwXagOTIxW8F5g5Y/s400/Greece+Current+Account+Deficit.png" alt="" id="BLOGGER_PHOTO_ID_5544731607311958258" border="0" /></a><br /><br />At the end of last week, risk premiums on 10-year Greek bonds over their German equivalents were still timidly nosing above 1,000 basis points, a level many consider to be the market signal that default is likely. And this despite the International Monetary Fund having announced the same day that the Greek reform programme is “broadly on track”.<br /><br />And then there is the return to the financial markets issue. Finance Minister George Papaconstantinou has repeatedly said the country would return to bond markets when the time was right sometime in 2011. This looks increasingly like wishful thinking, especially since the 2009 deficit revision by Eurostat, while the less than anticipated revenue performance means that Greece has already missed its first fiscal consolidation target. Such a lapse may convince inspectors from the EU and the IMF, but it is unlikely to cut too much ice with ultra conservative fixed income market participants.<br /><br />And, as Nick Skrekas points out in the Wall Street Journal, the numbers simply don’t add up. Greece has to raise €84 billion to repay interest and principle over the next three years, even assuming the force of the economic contraction doesn't mean even more missed deficit targets . Add to that an additional €70 billion for each of 2014 and 2015 in repayment of EU-IMF loans, and the calculation equals an unavoidable default, which is what the markets are signalling with there 1,000 to the sky is the limit spread on Greek 10 year bonds over bunds.<br /><br />Even in the pre-crisis days, Greece couldn’t realistically raise more than about €50 billion a year from markets that trusted it. And market participants know the ‘troika’ is being unrealistic in its expectations. Lack of conviction in the bond markets that Greece can survive without a default is creating a vicious cycle that keeps prospective borrowing costs elevated and thus makes eventual repayment even more unlikely. And round and round and round and round we go.<br /><br />In this sense the troika’s earlier inflexibility over the repayment postponement issue has been entirely self-defeating. The delay in letting the markets know that extension was a possibility is rumored to have been in part due to the German government's worries about what the reaction inside Germany would be to the news. Evidently borrowers are going to be able to kick the can a lot harder and a lot further down the road than previously imagined. Indeed only today Ireland is seemingly to get money over a nine year term, which makes it hard to see how exactly the European Financial Stability Facility can be wound up in 2013 as previously planned - indeed the way things are shaping up it looks like 2013 could be the year when it really gets going.<br /><br />Which, as John Dizzard notes in the Financial Times, would seem to create a new potential moral hazard problem, which is that if the funds in the pot are going to be limited, and if potential costs going forward are likely to be high, then we could see a rush to get in (before the funds are all used) with few in any hurry at all to leave. Giving Spain the prospect of 350 billion euros (or thereabouts) over seven and a half years mights seem very tempting, but it is unlikely that those in Rome would be happy to pay rather than join the queue standing next to the soup pot.<br /><br />So, what this all boils down to is, that along with the EU and IMF we can be in no doubt: the reform programme evidently is on track. The only issue which seems to divide everyone - and especially those office-bound Fund employees from their more financially savvy market-participant peers - concerns the exact name of the station towards which the train in question is heading.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-84052616758095711632010-10-28T10:29:00.001-07:002010-10-28T10:29:42.488-07:00Has the Market Finally Gotten it on the Eurozone Periphery?<p>By Claus Vistesen: Hull</p> <p><strong>Update:</strong> I was so caught up with Ireland today that I didn't notice how Greece also wants its part of the limelight. But fear not; Joseph Cotterhill from Alphaville delivers the goods as Greek spreads to the German benchmark rose above 10%. Basically, it is a mess at the moment in Greece with one of the biggest risks that the political balance is also shifting. Most remarkably however was the comments made by the Finance Minister Papaconstantinou that growth rate this year would be -4.0 and -2.5 to -3.0 in 2011. Add to this ongoing deficits (which will of course be smaller due to the contraction) and you are looking at an overall debt level that does not look too nice at all. Basically, the 2009 deficit is likely to be revised to 15% of GDP by the EU commission according to Alphaville and the IMF puts the 2010 deficit to around 7%. Now, figures are scarce here but wikipedia puts debt to GDP at 115% in 2009. So, with let us say a 5% deficit in 2011, a nominal growth rate of -2.5% and an initial debt level of 115% (just to play nice) my calculations suggest that Greece will be facing a debt to GDP level of some 130% at the end of 2011, a number which naturally will grow as we move on.</p> <p>---</p> <p>Popular wisdom has it that markets are always right or, more appropriately; that if you find your self on the wrong side of the market consensus the best cause of action is to join the ranks less you want to be rolled over by steamroller. However, it may take some time before the market corrects to the underlying fundamentals or so, at least, I will argue.</p> <p><a href="http://clausvistesen.squarespace.com/alphasources-blog/2010/10/14/cash-is-king.html">Last time I wrote on Ireland</a> I noted how the country's latest move to emphasize its strong cash position (as well as the fact that it announced the intention not to go to market to seek financing) was a wink to EU policy makers that either the current plan works or Ireland will need funding help. Private market funding at current and future expected rates is not an option and the really important question is whether the interest rates charge by <a href="http://clausvistesen.squarespace.com/alphasources-blog/2010/10/4/random-shots.html">some form of European SPV</a> would also be consistent with a recovery or simply another debt spiral. I have my doubts here.</p> <p>Indeed; with a the running deficit to GDP of 32% in 2010 it is absolutely necessary that Ireland addresses this as a <em>first </em>priority. No matter how much cash you have lying around or how much you expect to be able to get from a coordinated relief program (essentially borrowing with low rates and long maturity), the failure to react now would mean that the time path of public debt would prove instantly unsustainble as we moved into 2011 and 2012</p> <p>However, markets don't seem to be very comfortable with the prospects of very strong austerity measurse in Ireland.</p> <p>Quote Bloomberg</p> <blockquote> <p>Bond investors are losing faith in Ireland’s plan to lower the deficit as spending cuts threaten to undermine economic growth, reducing government revenue. Irish 10-year bond yields climbed within 50 basis points of the 454 basis-point record spread, set Sept. 29, relative to similar-maturity German bunds. Portugal’s spread fell about 1 percentage point against the German benchmark in the past month, the Greek-German yield gap narrowed 102 basis points and the Spanish spread was close to the lowest level since Aug. 10.</p> </blockquote> <p>It is important to understand the underlying message here. What drives the worry is not so much the debt and deficit itself, but more so that the severe austerity measures needed to restore the evolution of debt will derail the economy and thus become counterproductive. Indeed, this is the main issue which most OECD economies grapple with at the moment.</p> <p>But surely, it is not easy being Ireland at the moment. On one day, spreads climb because you are trying to plug the hole in the budget as you try to salvage a broken financial sector and the next spreads climb on growth fears as you introduce austerity measures in an attempt to correct the deficit incured in the first place.Look up the old proverb of <em>being stuck between a rock and a hard place</em> and you will find the European Periphery as a chief example.</p> <p>What is interesting in particular are the comments extracted by Bloomberg from various fixed income portfolio managers across Europe. They seem to me to be getting closer to a <a href="http://clausvistesen.squarespace.com/alphasources-blog/2010/10/4/random-shots.html">does not compute moment</a> of their own (all quotes are gathered by Bloomberg). Firstly, Dermot O’Leary, chief economist at Goodbody Stockbrokers simply turns the focus upside down and argues that now, surely, growth is the most important goal for Ireland.</p> <blockquote> <p>“With the scale of consolidation now known, the department’s strategy for returning the economy to growth” could “now be described as more important than the consolidation measures,”</p> </blockquote> <p>I wonder whether he would change his mind if the black hole of Anglo Irish takes the 2010 deficit/GDP figure to 40% (or perhaps 50%?). But there are other much more fundamental issues being raised; for example by John Fitzgerald a member of the central bank board.</p> <blockquote> <p>The risk is “the medicine is too severe so that, like chemotherapy, it puts the patient into decline,”</p> </blockquote> <p>Indeed, this is a risk and one which I (<a href="http://edwardhughtoo.blogspot.com/">and others</a>) have been banging on about the last 2 years, but the one I really liked was the comment by Ralf Ahrens from Frankfurt Trust and the simple yet crucial question;</p> <blockquote> <p>“There is this central question of where does growth come from.”</p> </blockquote> <p>Well, well. Aren't we coming full circle here?</p> <p>Allow me to repeat three questions I posed recently in relation to the ongoing efforts to solve the the crisis in many European economies.</p> <ul><li>How do you correct external competitiveness deficiency from within a currency union at the same time as implementing fiscal austerity without risking debt levels to spin out of control?</li><li>How long should Southern Europe and Ireland endure deflation relative to the core to restore external competitiveness (will Germany accept a lower external surplus as result)?</li><li>How might a sovereign restructuring in a Eurozone economy play out?</li></ul> <p>The first question is really the main issue at hand. In the absense of nominal currency devaluation you need to impose wage restraint and deflation in order to correct a large external balance. As this large external imbalance is reflected in a large domestic debt level there is a real risk that if the <em>entire </em>correction must come from the domestic price level, the level of debt in itself will spin out of control which then manifests itself in either large scale private sector defaults or default on the sovereign level. </p> <p>The main message here is simple macroeconomics. If you combine deflation and negative nominal growth rates over a prolonged period of time and given an already elevated debt level; your overall level of debt relative to the value of your activities (GDP) quickly become unsustainable.</p> <p>So how do correct then? Well, not without a little help from your friends which brings us to the second question.</p> <p>Consequently, this is not only about the European periphery suffering, it is about them suffering more than everyone else. Indeed, the recent ascent of the Euro is no good for them in so far as goes competitiveness outside the Eurozone and even inside Europe, it is starting to look like everybody's race to the bottom in terms of on whose back intra-Eurozone imbalances are supposed to correct. Naturally, a steady depreciation of the Euro would, strictu sensu, be welcome news for Greece, Ireland et al. Yet, this seems far off at the moment with the Fed doing the printing and the ECB reluctant to add further stimulus. On the concrete question of time, you just need to slice up the effects of say, a 30 % nominal devaluation (e.g. against the Euro or USD) which is the likely alternative scenario, I think, if any of the most troubled Eurozone economy had their own currencies. It then means that we would need to see a prolonged period of relative deflation to Core europe.</p> <p>This however would in itself be problematic since 5-10 years of slow pain would almost certainly result in a Japan type lost decade, but also be almost impossible from within the Eurozone (i.e. politically). So by proof of elimination we reach question three. Indeed, PIMCO's El-Erian recently argued that Greece is likely to default within 3 years and that this need not be cataclysmic. I fully agree.</p> <p>It is impossible to do any form of calculation here since we don't have any numbers that are coherent, but surely I would think that something along the lines of a 30% haircut on the principal and a notable extension of maturity is a likely result (but really, I have no idea!). The alternative would be that the rest of the periphery follows Ireland's example and simply leave the private market (although China et al. have indeed been fishing lately) and thus, they would have to be capitalised slowly from within an intra Eurozone structural fund (or through outrigth monetization by the ECB, but this is not going to happen I think).</p> <p>In the event of restructuring, big the question of the hole left on the balance sheet of Eurozone debt holders of peripheral bonds (let us think about foreign holders later). A couple of potential solutions have already been put forward.</p> <p>Leaving aside the Structural Fund which is not supposed to recapitalise private entities (at least not yet) it would mean that those banks either would have to enter the market to recapitalise, be recapitalised by their domestic governments (a deal which could form part of the default), or simply tranfers bonds at par to the ECB which tend would have to take the hair cut on its balance sheet.</p> <p>At the end of the day, this kind of rhetoric is still seen as fearmongering and disruptive in the Eurozone collective since there is still a strong sense of resolve around the fact that no sovereign in the Eurozone may be allowed to default/restructure on its debt. As such, you could argue that one glaring omission in my analysis is that I don't consider the <em>costs</em> of default. Well, they would naturally be substantial not only for the individual economies but for the Eurozone itself. However, when you run even a rudimentary simulation of the likely numbers it is pretty easy to see how this cannot go on. There is no exogenous source of economic growth that will help the periphery move in to a virtuous circle, there is only one big vicious one in which more austerity brings lower growth and deflation which in turn affects the level of debt to GDP.</p> <p>I admire resolve and I even believe that it is merited, but this is only to the extent that Germany (and France) are willing to assume their part of the bill (which will be very big) or to the extent that the ECB decides to employ wholly new and Fed-like policy tools.</p> <p>Absent this and leaving aside the question of whether Germany and France realistically would be able to foot the bill at all, the only question is if the markets are starting to get it, when will the shoe drop on the level of macroeconomic policy making?</p>CVhttp://www.blogger.com/profile/16843402165210120665noreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-45672310128822509642010-10-17T13:10:00.000-07:002010-10-17T13:12:18.919-07:00Mr Zapatero Said What..........?by Edward Hugh: Barcelona<br /><br />Spain's Tinsa Price Index was out last week, and showed Spanish property prices fell again in September, and at an accelerating rate. As Tinsa point out in their report, both "Metropolitan Areas and municipalities on the Mediterranean Coast," whose rates experienced a significant drop from the previous month, have contributed decisively to this steep decline".<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1YEPX0E-BSC0feiRy3vFVpEmXJFIGKLEQloVGkczvrxF5Bn_VNSv2irfWnbPhB8f4p9G_rzYbZRJMhxMBe47hqCLgTmx_THA-gotmGkvYDEVyQ7czeL_Y9ggkBAWM5JMjfa9vdWxZ96Y1/s1600/tinsa+one.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 241px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1YEPX0E-BSC0feiRy3vFVpEmXJFIGKLEQloVGkczvrxF5Bn_VNSv2irfWnbPhB8f4p9G_rzYbZRJMhxMBe47hqCLgTmx_THA-gotmGkvYDEVyQ7czeL_Y9ggkBAWM5JMjfa9vdWxZ96Y1/s400/tinsa+one.png" alt="" id="BLOGGER_PHOTO_ID_5529065112320060722" border="0" /></a><br /><br />In fact, looking at the chart the other way round, prices have now fallen some 18% from their December 2007 peak.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgBfounMUmgZaY20SWn5lB28Kz7u-Hf6WzPP8VTh5C7AGhR3Ah5ysCSe-A6JjG4K1WKhw1sTIXslY3rvKKwapa4hd5CO2sFcgwhnD76yW9IxwxilNylJ08jWlOuZaaZFZLapots19STEYhJ/s1600/tinsa+P2P.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 241px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgBfounMUmgZaY20SWn5lB28Kz7u-Hf6WzPP8VTh5C7AGhR3Ah5ysCSe-A6JjG4K1WKhw1sTIXslY3rvKKwapa4hd5CO2sFcgwhnD76yW9IxwxilNylJ08jWlOuZaaZFZLapots19STEYhJ/s400/tinsa+P2P.png" alt="" id="BLOGGER_PHOTO_ID_5529065436339477314" border="0" /></a><br /><br />The strange thing is that the latest Tinsa data contrast sharply with the most recent finding of Spain's National Institute of Statistics (INE) on the subject, since they suggest in their latest report that Spanish property prices <strong>actually rose</strong> in the second quarter (quarter-on-quarter) (and for the first time in the best part of 3 years), but this finding rather than reassure us that all is well (and as it should be) only serves to cast further doubt on the ability of the INE to maintain adequate statistics on the state of the Spanish economy, or at least to interpret the data they collect. This latest piece of statistical wizzardry <a href="http://www.blogger.com/%20http://www.spanishpropertyinsight.com/buff/2010/09/17/official-figures-claim-property-prices-rising-for-first-time-in-3-years/">lead Spanish property expert</a> (and author of Spain Property Insight blog) Mark Stucklin to say "If you believe that, you’ll believe anything". Frankly, I'm inclined to agree with him.<br /><br />Of course, <a href="http://www.cnbc.com/id/39441508/Is_Spain_Far_Worse_Off_Than_It_Looks">it has become rather fashionable to question INE data interpretation</a> of late (and <a href="http://spaineconomy.blogspot.com/2010/05/spains-unemployment-problem.html">I personally have had my problems with the seasonally adjusted employment numbers</a> - in fact <a href="http://economicresources.blogspot.com/2010/05/spains-unemployment-problem.html">see these collected screenshots of the the backward revisions</a> that were going on in the data as evidenced by Eurostat monthly reports) but this latest "faux pas" does make you want to ask "can't they get anything right"? In fact the Statistics Office house-price-data, is full of incredible and eye catching details, like the suggestion that new build sale prices only peaked in the third quarter of 2008, following which they only fell back 7.77% from peak, before taking off again, if we are to accept the official data version of things. So this must have been the "bottom" that Mr Zapatero refered to in his CNBC interview (see below). And this, as Mark Stucklin notes "despite a glut of up to 1 million newly-built homes, and discounts of up to 20pc or more on any developer’s price list you care to look at". So is this how one of the greatest housing busts in living history ends, with a whimper and not a bang? Somehow I doubt it.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXMd0hMQWM1yo_hMyHivddjufS1F6-X3bNaDJR6gwg0sMzKu-Ap60hEKwWsxoWIlL3Muc-71RxmwTKFYdYrKqQNpxbNm3EVhgvVtCF4jx_dMeNufb1Tgo8j5HPuuWkE-Izfs7JdIFNDkGl/s1600/Spain+Official+Property+Prices+Index.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXMd0hMQWM1yo_hMyHivddjufS1F6-X3bNaDJR6gwg0sMzKu-Ap60hEKwWsxoWIlL3Muc-71RxmwTKFYdYrKqQNpxbNm3EVhgvVtCF4jx_dMeNufb1Tgo8j5HPuuWkE-Izfs7JdIFNDkGl/s400/Spain+Official+Property+Prices+Index.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5529104664193025170" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhdP4JmXDrL1V2SnXV_sKt6VNbaLBRjZ-CXeqF-3qehla05DNt5Bd2qikaCVp73KpF7Rm_qlHDueWqJUtkFsvgZjyTkt18kgG8unlPLmiI1OAB1VUQSvu_9i9Th8Btbwccal1tQyEZe5EXa/s1600/Spain+Official+Property+Prices+New+Build+Index+P2P.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhdP4JmXDrL1V2SnXV_sKt6VNbaLBRjZ-CXeqF-3qehla05DNt5Bd2qikaCVp73KpF7Rm_qlHDueWqJUtkFsvgZjyTkt18kgG8unlPLmiI1OAB1VUQSvu_9i9Th8Btbwccal1tQyEZe5EXa/s400/Spain+Official+Property+Prices+New+Build+Index+P2P.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5529104770379387874" /></a><br /><br />Naturally, I'm sure its a pure coincidence that this latest "surprise price reversal" data came out just before Jose Luis Rodriguez Zapatero went to New York to kindly inform all concerned that the Spanish property market is now on the mend. In an interview with CNBC (<a href="http://www.la-moncloa.es/IDIOMAS/9/ENLACES/DocumentacionGeneral/CNBCinterviewsPresidentoftheGovernment">see this official Moncloa transcription of the interview if you have any doubt</a>), Prime Minister Zapatero repeated the INE claim, stating that house prices are beginning to rise in some areas, though not, he admitted, in the case of holiday homes. “In fact, in the last 2 to 3 months, we have seen that prices are not only not falling, but even rising in certain parts of Spain, where people buy their first home,” he told CNBC's Maria Bartiromo. This, he argued, shows that “demand appears to be on the rise.”<br /><br /><blockquote>MS. BARTIROMO: Are you expecting real-estate prices to continue coming down? Have they hit the bottom or not yet?<br /><br />PRIME MIN. ZAPATERO: I think that the price of housing has hit the bottom. It won't go down any more. For the past two or three months, what we see is that not only has it not dropped. But in certain parts of Spain, the price of housing has gone up. This is especially the case in those areas of -- not where people are buying their second house, if you like, with the prices there have still gone down a bit, but rather where they're buying their first, there the prices have gone down in the housing sector. So in general the prices have been stable recently, and they've even been increasing. So demand seems to be ticking up again.</blockquote><br /><br />Now, as that posse of irate INE defence vigilantes who may come chasing after me on this will no doubt tell you, the methodology they use is different from the Tinsa one, since it based on registered Notarial transaction prices, while the Tinsa index is based on asking prices, but come on, house prices rising again in Spain? Which world are we living in?<br /><br />Of course, there could be another explanation for this seeming discrepancy (apart from fudging the numbers that is) and that would be that many of the actually new build transactions are not real transactions at all, but rather paperwork ones, as the banks move over the developers unsold property onto the books of their special purpose subsidiaries, and don't mark down the price since they prefer not to show losses. Then, of course, the very same subsidiary offers the property for sale at a sizeable discount (and it shows up with the Tinsa index as an asking price), but since there are very few real new-build sales at the moment, these number never show up back in the notaries office, where all is quiet and orderly.<br /><br />Sure, the data show that new house sales "seem" to have bottomed, and even picked up a bit (see chart below), but talking to developers and estate agents out on the street, this doesn't seem to be the result of any real pick up in end user demand. It is more a question of banks responding to pressures from the Bank of Spain by moving their properties "out of sight" (if not out of mind). Meanwhile, the typical Spanish buyer is adopting a watch-and-wait approach, and will need a lot of convincing that they really have stopped falling before they move back in. Even the "experts" employed by the EU Commission are not convinced either, since they <a href="http://www.spanishpropertyinsight.com/buff/2010/10/08/eu-report-spanish-property-still-over-valued/">just published a report</a> stating that Spanish property prices were still 17% too high.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkGlSHTqfSKzbRm2N5WHhrX-J9LRa4DVR6PqPAnwG092uv-8TApJXMJL6c-cUOpoNX3uL28DdHnz7RYALbteGsy06ZOlz6XduH6aYFZPcM0AIhlL9GA0WWEWI1rgGBB9UF6pZY2DRuj_Fs/s1600/Spain+new+houses+sold.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkGlSHTqfSKzbRm2N5WHhrX-J9LRa4DVR6PqPAnwG092uv-8TApJXMJL6c-cUOpoNX3uL28DdHnz7RYALbteGsy06ZOlz6XduH6aYFZPcM0AIhlL9GA0WWEWI1rgGBB9UF6pZY2DRuj_Fs/s400/Spain+new+houses+sold.png" alt="" id="BLOGGER_PHOTO_ID_5529091989655600898" border="0" /></a><br />But if you want one, there is something more like a smokin gun out there which should tell us that this whole Spain property market recovery story is a bit strange, and that is the Bank of Spain data for total mortgage lending. This has hardly moved since the start of 2009 (see chart below) so it is far more easily reconcilable with the properties being transfered over to bank subsidiaries (complete with their "developer" mortgages) story, than it is with one of rising sales and rising prices.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0UvDeU-V_sZDG_ISrNtsUQ9HBIXU7I0XzACeGaRFsWDV_9lkwkKXNJiBnckkyjJqfUa8jBphI8e5SkgI2SYi691xDiILibMbCPNlR-ILoFLyCCa4uXhA-Zt_YLFnuubq7yyVy9uCW5CWJ/s1600/Spain+bank+lending+for+house+purchases.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0UvDeU-V_sZDG_ISrNtsUQ9HBIXU7I0XzACeGaRFsWDV_9lkwkKXNJiBnckkyjJqfUa8jBphI8e5SkgI2SYi691xDiILibMbCPNlR-ILoFLyCCa4uXhA-Zt_YLFnuubq7yyVy9uCW5CWJ/s400/Spain+bank+lending+for+house+purchases.png" alt="" id="BLOGGER_PHOTO_ID_5529098956414574914" border="0" /></a><br /><br />More than the house price story itself, which is hardly pleasing to the eyes, what I find most worrying is the way the Spanish administration seems to be boxing itself into a corner with its use of data. During the interview. Mr Zapatero also said the following in a response to a question about the outlook for the Spanish economy: "Well, our estimate is that we won't have any more quarters where growth will go down. We think that growth will continue to improve, and this will also improve confidence in the Spanish economy". But none other than Bank of Spain Governor Miguel Angel Fernandez Ordoñez recently asserted that the Spanish economy had visibly weakened in the third quarter, and the data we have certainly seem to back him up. And the fourth quarter outlook looks even worse. So which is it, will Mr Zapatero be able to eat humble pie, or will an army of bank analysts and hedge fund investors end up spending the whole xmas period going through all the Spanish data with a fine toothcomb? Mr Zapatero also says: "What's happening is that our plans are being fulfilled to the letter". This reminds me of other statements from other national leaders in other times. Would that those beyond the confines of his own small closed inner circle could find themselves able to agree with him when he makes such an assertion!Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-24001141213637142342010-10-16T13:53:00.000-07:002010-10-16T14:00:00.419-07:00An Unusual But Interesting Argument Which May Help To Understand Why QE2 Is Now Almost Inevitableby Edward Hugh: Barcelona<br /><br />For reasons which aren't worth going into now, I'm reading through a recent report by Deutsche Bank Global Markets Research entitled "From The Golden To The Grey Age" this afternoon. The report (all 100 pages of it, many thanks to researchers Jim Reid and Nick Burns who produced the thing) looks at the extent to which a variety of macro indicators - like GDP growth, inflation rate, equity yields, etc - may have been influenced by demographic forces over the last 100 years or so. It is certainly one of the most systematic reports of its kind I have seen, and well worth losing a Saturday afternoon to read.<br /><br />But in the middle, there is an argument which caught my eye, and I thought it worth reproducing. Basically the starting point is this chart, which if you haven't seen by now (or something like it) I'm not sure where exactly you've been during the last 2 or 3 years.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgwJ6JOHZc0TbfDis2n0g5gE4RhEP9h0r3MqeGXFZQg5dqBQnMjsWFVtKXZ3ak-fBeo2RmPXruDa7LaYp4vci9lmUp382iuP_5_zLVnyfMUzb2MNJMCdpKS6qT8FaApb4TZxgTDjViOHAgS/s1600/US+Debt+To+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 204px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgwJ6JOHZc0TbfDis2n0g5gE4RhEP9h0r3MqeGXFZQg5dqBQnMjsWFVtKXZ3ak-fBeo2RmPXruDa7LaYp4vci9lmUp382iuP_5_zLVnyfMUzb2MNJMCdpKS6qT8FaApb4TZxgTDjViOHAgS/s400/US+Debt+To+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5528677402697495202" border="0" /></a><br /><br />Obviously, just the most cursory of glances at the thing should lead even the most untrained of eyes to get the point that what is going on around us is not some passing phenomenon, and that there are deep structural factors at work.<br /><br /><br />As our DeutscheBank researchers put it: <br /><br /><br /><br /><br /><blockquote>As can be seen (from the above chart) there was a step change in the US economy’s indebtedness from the early 1980s onwards and then an additional one in the late 1990s/early 2000s. A similar picture is apparent across most of the Western World.<br /><br />Basically from the early 1980s to the onset of the Global Financial Crisis the economy added on more debt every year and business cycles were extended as a result. Indeed the Fed and Central Banks around the world were afforded the luxury of operating in a secular falling inflation regime (globalisation) that allowed them to cut rates, further allowing the accumulation of debt, every time the economy may have naturally been rolling over into a normal recession consistent with those seen through history. This debt accumulation undoubtedly helped smooth the business cycle and contributed to the period being known as the ‘Great Moderation’. This period came to a spectacular end with the onset of the crisis and it is possible that going forward we will revert to seeing business/credit cycles more like they were prior to the ‘Great Moderation’.</blockquote><br /><br /><br /><br />Now here comes the clever part. Our researchers then go on to take a look at the the average and median length of the 33 business cycles the US economy has seen since 1854. For the overall period they found the average cycle from peak to peak (or trough to trough) lasted 56 months (or 4.7 years). However, the averages are boosted by an occasional elongated "superbusiness cycle", and thus the median length is a much smaller 44 months (3.7 years). As they comment, such numbers must look very strange to those who have only ever analysed business cycles over the last 25-30 years. Within these 33 cycles the contraction period lasted 18 months on average or 14 months in terms of median length. This equated to the economy being in recession 31% or 32% of the time depending on whether you look at the averages or the median numbers. Taking just the period before the “Great Moderation” the average US cycle lasted 5 months less at 51 months (or 4.3 years) with the median at 42 months (3.5 years). Over this period the US economy was in recession 35% and 36% of the time respectively depending on whether you look at averages or the median.<br /><br />Now we used to think that all of that was behind us, but then we used to think that the "Great Moderation" had gotten things under control, and not simply temporarily extended the cycle length by facilitating long-term-unsustainable levels of indebtedness. So in fact, given that, as they say some sort of cycle or other has been with us since at least biblical time, what we might now expect are more "normal" cycles (in historical terms), which put a little better means shorter ones with more frequent recessions.<br /><blockquote><br />"Given all we know about the ‘debt supercycle’, it is likely that the onset of the Global Financial Crisis ended the “Great Moderation” period. Unless we find a way of continually adding more debt at an aggregate level in the Developed World it is likely that we will see much more macro volatility and more frequent business cycles going forward. Given the fact that Developed World Government balance sheets are under pressure, and given that interest rates around the Western World are close to zero, the post-crisis ability to fine tune the business cycle is extremely limited. We may need to put an immense amount of faith in the experimental force of Quantitative Easing to deliver economic stability. This will be an experiment with little empirical evidence as to how it will turn out. For now the base case must be that we revert more towards business cycles more consistent with the long-term historical data".</blockquote><br /><br />So then our authors do their calculations concerning the average length of US cycles since 1854 in order to make a rough estimate of when the next few US downturns will start, as illustrated in the following chart.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWA9zVfFw9DRAH0-WtQSTPfsBS2SpeNXS2TOgtZ5DqLTGKnvc7uRr69FZHQgsqXDzRJRftVXrIcCxFN9JN9vPwB5_Vi5FHJfBdKCnhVdzwGqUYqU2L_k-kgOBNgYquSxhBQb_hATieekT_/s1600/US+Recession+Estimates.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 126px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWA9zVfFw9DRAH0-WtQSTPfsBS2SpeNXS2TOgtZ5DqLTGKnvc7uRr69FZHQgsqXDzRJRftVXrIcCxFN9JN9vPwB5_Vi5FHJfBdKCnhVdzwGqUYqU2L_k-kgOBNgYquSxhBQb_hATieekT_/s400/US+Recession+Estimates.png" alt="" id="BLOGGER_PHOTO_ID_5528682403043621618" border="0" /></a><br /><br />Now, without dwelling on the gory details, if we look at the spread between the upside, median, and downside cases, we could pretty rapidly come to the conclusion that the next US recession has a high probability of starting sometime between next summer, and the summer of 2012 - which, as you will appreciate, isn't that far away. I am also pretty damn sure that Ben Bernanke and his colleagues over at the Federal Reserve appreciate this point only too well, and hence their imminent decision on more easing, since a recession hitting the US anytime from next summer will really come like a jug of very icy water on that very fragile US labour market, not to mention the ugly way in which it might interact with the US political cycle.<br /><br />I think the mistake many analysts are making at this point is basing themselves on some sort of assumption like, "if the recession was deep and long, then surely the recovery should be just as pronounced and equally long", but, as the DeutscheBank authors bring to our attention, business cycles just don't work like that.<br /><br />Now, why I think this is an interesting argument is that the starting point for looking at the recovery is rather different from the norm, in that instead of peering assiduously at the latest leading indicator reading, they do a structural thought experiment, and work backwards from the result. Now, one thing I'm sure Ben Bernanke isn't is stupid, so it does just occur to me that either he, or someone on is team, is well able to carry out a similar kind of reasoning process.<br /><br /><br /><span style="font-weight: bold;">Watch Out, Here Comes The QE2</span><br /><br />In fact, it would be an understatement to say that the forthcoming QE2 launch is causing a great deal of excitement in the financial markets. As the news reverberates around the world, it seems more like people are getting themselves ready for some kind of "second coming". Right in the front line of course are the Europeans and the Japanese, and the yen hit yet another 15 year high (this time of 81.11 to the dollar) during the week, while the euro was up at 1.4122 at one point. Greeks, where are you! Can't you engineer another crisis? We need help from someone or we will all capsize in the backwash created by this great ocean liner as it passes.<br /><br />But joking aside, a weaker USD is going to be both the natural and the intended consequence of the coming bout of additional QE by the Fed, and it will have a strong collateral effect on the already weaked and export dependent economies of the EuroArea and Japan.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgiWk2YV_p60YEYuI8_dsODOWzzDDYoKyqAFUtD2bBNJKWCuH2IdGxx1eU2eANkjJVHlsd8LRQUW_ORjvNWhFsYNnVsdQWxdKOTgUrDwInMluslh7FWo1iDczK-ObhSoY-nFqrjLBlVR7qJ/s1600/Weak+USD.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 197px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgiWk2YV_p60YEYuI8_dsODOWzzDDYoKyqAFUtD2bBNJKWCuH2IdGxx1eU2eANkjJVHlsd8LRQUW_ORjvNWhFsYNnVsdQWxdKOTgUrDwInMluslh7FWo1iDczK-ObhSoY-nFqrjLBlVR7qJ/s400/Weak+USD.png" alt="" id="BLOGGER_PHOTO_ID_5528688392067775666" border="0" /></a><br /><br />With this prospect as the background, it should not come as a surprise that talk of currency wars and competitive devaluations is rising by the day. Japan only last week threatened "resolute action" against China and South Korea, Thailand has placed a 15% tax on bond purchases by non resident investors, and central banks from Brazil to India are either intervening to try and keep their currency from rising too fast, or threatening to do so.<br /><br />And the seriousness of the situation should not be underestimated. Many have expressed disappointment that the recent IMF meeting couldn't reach agreement, and hope the forthcoming G20 can do so. But really what kind of agreement can there be at this point, if the real problem is the existence of the ongoing imbalances, and the inability or unwillingness of the Japan's, Germany's and China's of this world to run deficits to add some demand to the global pool. Push to shove time has come, I fear, and if this reading is right then it is no exaggeration to say that a protracted and rigourously implemented round of QE2 in the United States could put so much pressure on the euro that the common currency would be put in danger of shattering under the pressure. Japan is already heading back into recession, as the yen is pushed to ever higher levels, and Germany, where the economy has been slowing since its June high, could easily follow Japan into recession as the fourth quarter advances.<br /><br />Indeed, I think we can begin to discern the initial impact of the QE2 induced surge in the value of the euro in the August goods trade data. The EuroArea 16 have been running a small external trade surplus in recent months, and to some extent the surplus has bolstered the region's growth. It is this surplus that is now threatened by the arrival of the QE2. The first flashing red light should have been the news that German exports were down for the second month running in August, but now we learn from Eurostat that the Euro Area ran a trade deficit during the month.<br /><br /><blockquote>"The first estimate for the euro area1 (EA16) trade balance with the rest of the world in August 2010 gave a 4.3 bn euro deficit, compared with -2.8 bn in August 2009. The July 20102 balance was +6.2 bn, compared with +11.9 bn in July 2009. In August 2010 compared with July 2010, seasonally adjusted exports rose by 1.0% and imports by 1.8%".</blockquote><br /><br />Basically the eurozone countries had been managing to run a timid trade surplus (see chart below, which is a three month moving average to try and iron out some of the seasonal fluctuation) and this had been underpinning growth to some extent. Now this surplus is disappearing, and with it, in all probability, the growth. Maybe we won't get a fully fledged "double dip" in the short term, but surely we will see a renewed recession (and deepening pain) on the periphery and at the very least a marked slowdown in the core.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi6ZKXibWnJommsAVf7N2mE7Stee6bl8u0L3-BD_GcvjN7ax5xW88jbzmwaagrkjk1zupAJ96KqOjRVRCGqiW0eD1ZOSNpOCxZPEoF1k_IpG56nN2_Ub4JZiJqWdG65VIzEqcbu2DbT4lbP/s1600/EuroArea+Trade+Balance.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi6ZKXibWnJommsAVf7N2mE7Stee6bl8u0L3-BD_GcvjN7ax5xW88jbzmwaagrkjk1zupAJ96KqOjRVRCGqiW0eD1ZOSNpOCxZPEoF1k_IpG56nN2_Ub4JZiJqWdG65VIzEqcbu2DbT4lbP/s400/EuroArea+Trade+Balance.png" alt="" id="BLOGGER_PHOTO_ID_5528690838317438802" border="0" /></a><br /><br />In fact the current situation is extraordinarily preoccupying. We are now in the fourth year of the present crisis (however you choose to term it, the second great depression, the very long recession, or whatever) and there seems to be no sustainable solution in sight. The underlying problems which gave birth to the crisis are excessive debt (both private and public) and large global imbalances between lender and borrower countries, and neither of these issues has so far been resolved, nor are there proposals on the table which look capable of resolving them.<br /><br />And unemployment in the United States (which is currently at 9.6%, and may reach 10% by the end of the year) is causing enormous problems for the Obama administration. The US labour market and welfare system are simply not designed to run with these levels of unemployment for any length of time. In Japan the unemployment rate is 5.1%, and in Germany it is under 8%. So people in Washington, not unreasonably ask themselves why the US should shoulder so much extra unemployment and run a current account deficit just to maintain the Bretton Woods system and the reserve currency status of the US Dollar.<br /><br />My feeling is that the US administration have decided to reduce the unemployment rate, and close the current account deficit, and that the only way to achieve this is to force the value of the dollar down. That way it will be US factories rather than German or Japanese ones that are humming to the sound of the new orders which come in from all that flourishing emerging market demand.<br /><br />I think it is as simple and as difficult as that.<br /><br />The problems created by the way the crisis has been addressed now exist on a number of levels. In emerging economies like Brazil, India, Turkey and Thailand, ultra low interest rates in the developed world are creating large inward fund flows which are making the implementation of domestic monetary policy extremely difficult, and creating sizeable distortions in their economies.<br /><br />At the same time, a number of developed economies like Spain, the United States, the United Kingdom became completely distorted during the years preceding the crisis. Their private sectors got heavily into debt, their industrial sectors became too small, and basically the only sustainable way out for them is to run current account surpluses to burn down some of the accumulated external debt. Traditionally the solution to this kind of problem would be to induce a devaluation in the respective currencies to restore competitiveness, but in the midst of an effectively global crisis doing this is very difficult, and only serves to produce all sorts of tensions. As Krugman once said, "to which planet are we all going to export".<br /><br />At the same time, two of the world's largest economies - Germany and Japan - have very old populations, which effectively means (to cut a long story short) they suffer from weak domestic demand, and need (need, not feel like) to generate significant export surpluses to get GDP growth and meet their commitments to their elderly population. The very existence of these surpluses also produces tensions, and demands for them to be reduced. But this is just not possible for them, and Japan is the clearest case. For several years Japan benefited from having near zero interest rates and becoming the centre of the so-called global "carry trade", which drove down the currency to puzzling low levels, and made exporting much easier. Large Japanese companies were even expanding domestic production and building new factories in Japan during this period (a development <a href="http://japanjapan.blogspot.com/2007/06/toyota-and-honda-increasing-factory.html">which had Brad Setser scratching his head at the time</a>, trying to work out how the yen could have become so cheap). <br /><br />Then the crisis broke out, the Federal Reserve took interest rates near to zero, and the United States became the centre of the carry trade. The result is that every time the Fed threatens to do more Quantitative Easing the yen hits new 15 year highs, even while the dollar continues its decline, with the result that Toyota are having a change of heart, and are now <a href="http://www.reuters.com/article/idUSTOE69F00420101016">thinking of closing a plant in Japan to move it to Mexico</a>. The present situation is just not sustainable for Japan, which is basically being driven back into what could turn out to be quite a deep recession.<br /><br /><br />Unfortunately I think there is no obvious and simple solution to these problems. As we saw in the 1930s, once you fall into a debt trap, it can take quite a long time to come out again. You need sustained GDP growth and moderate inflation to reduce the burden of the debt, and at the present time in the developed world we are likely to get neither. In the longer term, the only way to handle the presence of some large economies which structurally need surpluses is to find others who are capable of running deficits, but this is a complex problem, since as we have seen in the US case, if the deficit is too large, and runs for too long, the end result is very undesireable. Basically the key has to lie in reducing the wealth imbalance which exists between the developed and the developing world, but this is likely to prove to be a rather painful adjustment process for citizens in the planet's richer countries, so policy makers are somewhat relectuntant to accept its inevitability.<br /><br /><br />Basically, the structural difficulty we face is that all four major currencies need to lose value - the yen, the US dollar, the pound sterling and the euro - and of course this basically is impossible without a major restructuring of what has become known as Bretton Woods II. The currencies which need to rise are basically the yuan, the rupee, the real, the Turkish lira etc. But any such collective revaluation to be sustainable will need to be tied to a major expansion in the productive capacity of the economies which lie behind those currencies.<br /><br /><br />In fact, the failure to find solutions is increasingly leading to calls for protectionism and protectionist measures. The steady disintegration of consensus into what some are calling a "currency war" is, as I said above, another sign of this pressure. On one level, the move to protectionism would be the worst of all worlds, so I really hope we will not see this, but if collective solutions are not found, then I think we need to understand that national politicians will come under unabating pressure from their citizens to take just these kind of measures. The likely consequence of them succumbing to this pressure, which I hope we will avoid, would be another deep recession, possibly significantly deeper than the one we have just experienced. And, not least of the worries, the future of the euro is in the balance at the present time.<br /><br />The structural imbalances which we see at the global level, between say China and the United States, also exist inside the eurozone, between Germany and the economies on the periphery (Ireland, Portugal, Spain, Italy, Greece). These latter countries failed to take advantage of the opportunities offered by the common currency to carry out the kinds of structural reform needed to raise their long run growth potential, and instead they simply used to cheap money available to get themselves hopelessly in debt. At the same time the crisis has revealed significant weaknesses in the institutional structures which lie behind the monetary union, weaknesses which go way beyond the ability of some members to fail to play by the rules when it comes to their fiscal deficits. Steps are now being taken in a night-and-day non-stop effort to try to put the necessary mechanisms in place, but it is a race against the clock, and it is not at all guaranteed that the attempt will be succesful, especially if the volume of liquidity about to hit the global financial system drives the euro onwards and upwards beyond supportable limits.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-19043437603570705992010-10-14T09:26:00.000-07:002010-10-14T09:29:11.936-07:00Cash is King<p>By Claus Vistesen: Hull<br /></p><p>It is not that I don't enjoy a good old bull/teflon run as much as the next guy but just to provide some form of balance to the current QEeasy Money Hymn I almost choked on my oatmeal earlier this week when I loaded up Bloomberg and learned that everything suddenly was fine in the erstwhile whipping boy (alongside Greece) of the Eurozone as the economy <a href="http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=aY7aEkIC_394">apparently has the cash</a> to starve off any foreign bond vigilantes;</p> <p>(quote Bloomberg)</p> <blockquote> <p>Ireland expects its 20 billion-euro ($28 billion) cash pile to stave off a Greek-style rescue, as the government taps the funds to avoid paying record rates to borrow. The government canceled next week’s debt auction and another scheduled for November after the yield on 10-year Irish bonds rose to a record 454 basis points above benchmark German bunds. Finance Minister Brian Lenihan has said Ireland is “fully funded” through the middle of 2011. The country has 4.4 billion euros of bonds maturing next year, compared with about 27 billion euros in Greece.</p> </blockquote> <p>I find this fascinating for a number of reasons. First of all there is root of the problem itself in the form of Anglo Irish Bank which will cost Ireland perhaps up to 30 billion Euros and will be responsible for a fiscal deficit in 2010 to the tune of of an unbelievable 32% of GDP. Naturally, this is expected to be a one-off expense and the whole exercise on cancelling auctions is because Ireland feels that the yields it would be able to borrow for at the moment would not reflect the long term health of the economy.</p> <p>This makes sense. Why borrow if you don't have to and especially if you are not happy with the terms put forward by your potential creditor. On this point I am, in principle, on Ireland's side as it were. But what if costs for bailing out Irish banks are understated? Indeed, what is the real cost of assuming the entire bad loan book of Irish banks with no haircuts to bondholders or no restructuring of any kind? I don't know, but more importantly; I am not sure the people concerned in Ireland know either. After all, the fact we are now looking at a +30% deficit as % of GDP in 2010 was not part of any of the official rescue manuals I think.</p> <p>Consequently, let me throw another number at you; 3 % of GDP which is the fiscal deficit targeted for 2014 and which the market is supposed to take as collateral for a lower yield on Irish debt offerings in 2011.</p> <p>Yet, is this plausible?</p> <p>Basically, you have a <em>confirmed</em> 32%/GDP deficit today and you are promising to bring this down to 3% in a manner of 3 years. What are your assumptions here? What kind of nominal growth in GDP is build into the model? How will national debt evolve over this period? I am sure the good people at the National Treasury Management Agency are busy calculating just that as I type, but the problem is more profound.</p> <p>Ireland has basically made the bet that in using its remaining reserves today and thus avoiding going to the market it can bring back its house in order and then return to borrow at that time, but this is circular thinking. The main question is whether Ireland has enough money to bail out its banking system such as it is. Alan McQuaid, quoted by Bloomberg, puts it well;</p> <blockquote> <p>“They are taking a gamble that the budget will deliver and get spreads down,” said Alan McQuaid, chief economist at Bloxham Stockbrokers in Dublin. “If that doesn’t happen, maybe you skip a few auctions at the beginning of the year. But at some point, you have to go to the market. If you can’t go to the market, then you have to look at outside aid.”</p> </blockquote> <p>And Danske is even more sanguine, but then again they would be wouldn't they as they own National Irish Bank and thus effectively depend on this gamble to succeed (at least in terms of the health of their Irish operations).</p> <blockquote> <p>“The government has a significant problem” unless yields fall, said Soerensen of Danske Bank, which owns Dublin-based National Irish Bank. “But it isn’t under any immediate pressure to raise cash, and even in the unlikely event that the government had to call upon IMF/EU aid, investors would still get paid. There isn’t going to be a default.”</p> </blockquote> <p>But I think that we are still missing the main point here. This is not only a question of how dubious it is that Ireland can get its house back in order (and what kind of economic pain it will take) it is also a matter of whether it is in Ireland's interest to enter the market <em>at all</em>. Essentially, the current interest rates are unpayable for Ireland today but also in the middle of 2011 since this is where, presumably, the full force of fiscal contraction will be put on the Irish economy.</p> <p>So, my reading of this is that Ireland has now played itself into whatever deal it can broker with the IMF and EU and while I may be persuaded otherwise by a credible fiscal plan it is not the actual promise I will be looking at but the assumptions of debt/gdp and nominal GDP growth which underlies it.</p> <p>Until then, Ireland can continue to heed the old proverb that cash is king; it sure is ... until you run out.</p>CVhttp://www.blogger.com/profile/16843402165210120665noreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-16414574328870800442010-10-11T12:25:00.000-07:002010-10-11T13:56:21.960-07:00Estonia's Now-You-See-Me Now-You-Don't Inflation Rateby Edward Hugh: Barcelona<br /><br />Just to follow up on <a href="http://balticeconomy.blogspot.com/2010/08/estonias-long-awaited-recovery-may-be.html">my recent long Estonia post</a>, a couple of new data points have caught my attention recently: the <a href="http://www.stat.ee/37824">sharp rise in Estonian inflation</a> and the <a href="http://www.stat.ee/38036">ongoing goods trade deficit</a>.<br /><br />In the first place it is worth noting that Estonia's trade deficit went UP again in August. Of course, the countries ongoing services surplus takes some of the edge off, by, since Estonia is now an export driven economy, to return to stable growth and create that much needed employment Estonia needs a trade surplus, not a deficit. Of course, the headline catcher is that August's export were up 37% over August 2009. The number looks a little less impressive when you notice that imports were also up by 34%, and take in that a significant proportion of exports are imports which are re-exported, and then you look at the chart (below) and see that both are still running at levels well below their pre crisis peaks.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjTKb_rYKygJeC5bFN8DnlM8x7gChXa8-kcc50bG1egLxaToQVi3zFIykfuqbU7UA0Y6VWl5CHoq9Sw81pUBBGAGbZ0MqYBCr035Z6b3udCpzBZYCLkZ8y1ADNhuJOU7J9Qd0M5qojtkL5R/s1600/estonia+imports.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjTKb_rYKygJeC5bFN8DnlM8x7gChXa8-kcc50bG1egLxaToQVi3zFIykfuqbU7UA0Y6VWl5CHoq9Sw81pUBBGAGbZ0MqYBCr035Z6b3udCpzBZYCLkZ8y1ADNhuJOU7J9Qd0M5qojtkL5R/s400/estonia+imports.png" alt="" id="BLOGGER_PHOTO_ID_5526797180839589346" border="0" /></a><br /><br />To add insult to injury, despite the rapid export rise, Augusts trade deficit - some 71 million euros - actually increased slightly when compared to August of the previous year.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEghXyCCTCtXJgpUesuj6CvqzDu17BB0MRchfR3_iT3bnp7XuAFxky0BkBwJclcKVgcRE8WBd1J5raxl7_Ei-28qhHH9iHPmppZMrPTojLIHFMrkmnnGuGZJMkHZGCMuzR_AsBvbOSVGZu1U/s1600/estonia+trade+deficit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 225px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEghXyCCTCtXJgpUesuj6CvqzDu17BB0MRchfR3_iT3bnp7XuAFxky0BkBwJclcKVgcRE8WBd1J5raxl7_Ei-28qhHH9iHPmppZMrPTojLIHFMrkmnnGuGZJMkHZGCMuzR_AsBvbOSVGZu1U/s400/estonia+trade+deficit.png" alt="" id="BLOGGER_PHOTO_ID_5526796384840259138" border="0" /></a><br /><br />And here's the smoking gun which can help us understand why, despite the legendary "internal devaluation, the underlying Estonian trade deficit continues: the ongoing surge in inflation, itself in large part a by-product of the tax increases and energy subsidy reductions made to keep the fiscal deficit under control .<br /><br />According to Statistics Estonia, the consumer price index was up by an annual 4.0% in September, and by 0.8% when compared to August this year. Goods were up 4.5% and services 3.0%. Food prices were part of the problem, since they were up 7.0%. But, as the statistics office report informs us, government administered prices of goods and services were up by 8.1% while non-regulated prices were only up by 2.7% - that's the giveway datapoint, I think.<br /><br />Two fifths of the inflation was the result of a 6.6% price increase in food and non-alcoholic beverages, but the 10.2% price increase of electricity, heat energy and fuels accounted for 25% of the total, and the 8.2% excise duty induced price increase in alcoholic beverages and tobacco also had a significant impact on the consumer price index.<br /><br />So inflation is rising, but even worse, <a href="http://www.businessweek.com/news/2010-09-26/estonia-has-few-tools-to-stem-inflation-premier-ansip-says.html">so too are inflation expectations</a>. <blockquote>Inflation expectations by Estonian consumers continued to rise in September, according to Konjunktuuriinstituut, an economic research institute in Tallinn. The outlook is “certainly” affected by the prospect of euro adoption, the institute said.<br /><br />Thirty-five percent of consumers polled by the institute this month expect inflation to accelerate in the next 12 months, compared with 32 percent in August, and 5 percent a year earlier, it said.</blockquote><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg3-YZ2gT6IN0F6ZspH8kvp5FkZlplE5gnCATlY5OgBL61WodYyca_JeF1t7qdZ5fhnfm7PfdKM73q0_zTjrBnP2ezo2lzSdgxyf3eqnNc_MBF5NYhI81yA_Lt4ZHh7j4gp7c2Q6Uly1xqN/s1600/Estonia+%26+EA16+inflation+compared.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 218px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg3-YZ2gT6IN0F6ZspH8kvp5FkZlplE5gnCATlY5OgBL61WodYyca_JeF1t7qdZ5fhnfm7PfdKM73q0_zTjrBnP2ezo2lzSdgxyf3eqnNc_MBF5NYhI81yA_Lt4ZHh7j4gp7c2Q6Uly1xqN/s400/Estonia+%26+EA16+inflation+compared.png" alt="" id="BLOGGER_PHOTO_ID_5526797252763180194" border="0" /></a><br /><br />So, if those taking the policy decisions aren't careful Estonia may be about to loose its "poster boy" image, and find itself added to the ranks of the "fallen angels". The above comparison of Euro Area 16 and Estonia CPI inflation makes it look awfully like the timing of the tax and subsidy changes was calculated to get good inflation readings during the key euro decision window. It is hard to believe that neither the central bank nor the ECB could see the current surge coming - or if they couldn't, then the best you could say is that they were extraordinarily incompetent in their handling of the issue. And if you look at the competitiveness loss the price index reveals since the start of 2007 (even) the short period of deflation has nowhere near compensated for it, and the current price surge will soon eat it what little competitiveness improvement there has been all away.<br /><br />Of course, the central bank has expressed some concern, “There is a threat the present price and wage levels will not sufficiently support new investment and job creation,” it said in its latest economic report, although it stressed that it considered the increase in ongoing inflation due to rising food prices is likely to be temporary.<br /><br />All of which only confirms my impression that the Estonia entry decision was made in haste, coinciding as it did with May's sovereign debt crisis. The decision was a kind of vote of confidence in the resilience of the Euro Area: "look, we aren't about to fall apart, we're even accepting new members". In fact ECB President <a href="http://online.wsj.com/article/BT-CO-20100919-703207.html">Jean-Claude Trichet almost said as much on a recent visit to Tallinin</a>. Europe's economic and monetary union is committed to accepting further members, he stressed. "The euro area is not a closed shop," M. Trichet said, while attending a festive event to celebrate Estonia's upcoming accession to the eurozone. Rather, he said, it is open to any country "that fulfills any of the preconditions in a sustainable manner."<br /><br />The keyword here is "sustainable". As <a href="http://fistfulofeuros.net/afoe/is-estonias-euro-membership-a-done-deal/">reported on this blog</a>, there were those within the ECB, and most notably ECB executive director Juergen Stark, who opposed the decision, by simply arguing that, in the light of Greece's inability to endure the discipline of EMU membership, future applicants should be screened more tightly. In the past, membership had rested on the ability to conform with numerical targets on inflation, public debt and exchange rate at a specific point in time. Stark spoke of the need for countries to demonstrate that their compliance with the entry criteria is sustainable beyond the snapshot moment. As we can see, at least in terms of inflation, it is very hard to argue that Estonia's economic performance is.<br /><br />Jean-Claude Trichet also took advantage of his visit to stress that Estonia must remain “alert” on price developments and take “forceful” action to stem inflation after joining the euro-region economy. But, understandably, <a href="http://www.businessweek.com/news/2010-09-26/estonia-has-few-tools-to-stem-inflation-premier-ansip-says.html">Prime Minister Andrus Andrip replied</a> that Estonia is now going to have relatively “few tools” to control price increases. The main technique available is to run a fiscal surplus to drain demand, but with an economy which is suffering from the level of output loss that Estonia's is this is hardly contemplateable.<br /><br />Basically it would have been much more advisable to resolve these issues before joining the euro, but now it is a little late for that, so, who knows, maybe Estonia will eventually become the first candidate for the <a href="http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO%2F10%2F454&format=HTML&aged=0&language=EN&guiLanguage=en">recently proposed EU imbalances surveillance mechanism</a>.<br /><br />As the press release puts it: "The global economic and financial crises, followed by the so-called debt crisis, exposed the need for reinforced economic governance in the Economic and Monetary Union (EMU). Economic policies need to be better co-ordinated and surveillance enhanced".<br /><br /><blockquote>"Surveillance would start with an alert mechanism that aims at identifying Member States with potentially problematic levels of macroeconomic imbalances. The alert mechanism would consist of a scoreboard complemented by expert analysis".<br /><br />"The scoreboard would be composed of a set of indicators in order to identify timely imbalances emerging in different parts of the economy. The set of indicators should be sufficiently large to cover any possible case of major imbalance and making sure that it is sufficiently sensitive to detect imbalances early on. Possible indicators would most likely include both external (e.g. current accounts, real effective exchange rates) and internal ones (e.g. private and public sector debt). The composition of the scoreboard may evolve over time due to changing threats to macroeconomic stability or advances in data availability".<br /><br />"Alert thresholds would be defined and announced for each indicator. The thresholds should be seen as indicative values which would guide the assessment but should not be interpreted in a mechanical way. They should be complemented by economic judgment and country-specific expertise".</blockquote><br />But looking at that rising inflation profile, and thinking of Prime Minister Ansips statement that the country has few tools left with which to tackle the problem, whoever would have thought that just a few short years ago <a href="http://www.euractiv.com/en/euro/euro-zone-slovenia-lithuania-hold/article-155340">Lithuania had its application to join the Euro turned down simply because its inflation wasn't considered to be sufficiently under control</a>. My, my, how things change.<br /><br /><blockquote>On account of its 2.63% March 2006 inflation, Lithuania has for now failed to qualify for the euro zone, while Slovenia is all set to adopt the euro in January 2007.<br /><br />Lithuania meets all the criteria for the adoption of the common European currency, except for the one on inflation. The Baltic state's latest inflation figure is only marginally higher than the 2.60% benchmark applied by the Commission and the European Central Bank to decide whether a country is fit to adopt the common European currency.<br /><br />According to Monetary Affairs Commissioner Joaquin Almunia, the criteria, laid down in the EU's Stability and Growth Pact, are there to be rigorously enforced. </blockquote>Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-13408153860440865762010-10-04T14:29:00.000-07:002010-10-04T14:31:46.458-07:00Is A 6 percent 2011 Deficit Realistically Within Reach For Spain?by Edward Hugh: Barcelona<br /><br />Last Thursday Moody's Investor Service cut Spain's Sovereign credit - to Aa1 from AAA - thus removing the last of the country's highly-valued triple-A ratings. The move really surprised no one - in this case the Moody's rating could be regarded as a lagging indicator on the health of Spain's finances - since the two other "majors" (S&Ps and Fitch) had long taken the decision, and the market predictably shrugged off the news, as if to say "what else is new". But there was one small detail in the report which should have attracted more attention than it has: the agency explicitly stressed that it was the government's show of determination to reduce its very large fiscal deficit in the near term which influenced their decision to limit the downgrade to just one rating notch, and this was also the reason the rating had been assigned, for the time being, a stable outlook. Which means, of course, that should there be any slippage in that determination, any wearying, or falling asleep at the wheel, then the outlook would rapidly move to negative, and more downgrades could be anticipated.<br /><br />This creates an interesting situation, since I am by no means as convinced as many conventional journalists seem to be that the present fiscal situation is entirely under control. And since I do think Spain is going to come under increasing scrutiny from all points of view as we enter 2011, especially if Ireland and Portugal are ultimately forced to seek some sort of financial rescue, then any "accidental" slippage this year will inevitably mean even deeper cuts and a lot more pain next year, since Elena Salgado and José Luis Zapatero very definitely have pinned their shirts to the mast on the question of getting the deficit down to 6% of GDP in 2011. If this target is not achieved, and in a way which satisfies reasonably close inspection, then I think the country really will face the wrath of the markets, and in this sense the destiny of the 46 million odd people who live in the country very much is harnessed to the credibility and realisability of the budget plan Elena Salgado is about to present to the Spanish parliament.<br /><br /><strong>The Story So Far</strong><br /><br />According to most of the reports you read in the press these days market confidence in Spanish debt is rising based on the growing conviction that the Spanish government will be able to comply with its deficit commitments. I somehow doubt that this is the complete story (as <a href="http://fistfulofeuros.net/afoe/and-then-there-were-none/">I explained in this post</a>), and think it is as much a case of markets being focused at this point on whether or not Ireland and Portugal will ultimately be forced to have recourse to the European Financial Stability Facility (EFSF), and that they are being detached from Spain as much as Spain is detaching itself from them. At this point in time Spain is simply in the waiting room, in a state of grace or being given one last chance, and if the opportunity is not clearly seized with both hands then downgrades and widening spreads will almost certainly follow.<br /><br />Now, according to the "official version" what is happening if that Spain's fiscal deficit is steadily coming nicely under control as the economy returns to growth and the government squeezes its spending harder and harder. There are only two difficulties with this story. In the first place Spain's economy already appears to be moving back into contraction (the <a href="http://www.bloomberg.com/news/2010-09-30/bank-of-spain-says-country-s-economy-may-have-weakened-in-third-quarter.html">Bank of Spain is now talking of a "weakening" of GDP</a> in the third quarter, and <a href="http://www.laht.com/article.asp?ArticleId=368111&CategoryId=12395">only last Friday the government itself revised up its unemployment forecast for 2011, from 18.7 percent to 19.3 percent</a> to reflect the way the impact of the spending cuts is expected to hit growth). Indeed Moody's itself stressed their scepticism over the government's growth forecast. “Over the next few years the Spanish economy is likely to grow by only about 1 percent on average,” according to Kathrin Muehlbronner, a Moody’s vice-president and lead analyst for Spain. And this is more optimistic than S&Ps, who seem to think trend growth in the years to come will be more like 0.7 percent.<br /><br />Secondly, and this is the important point at this stage, the part of the deficit which is apparently reducing at this point is the central government one: we are simply not being given the necessary information on the state of Autonomous Community and Local Authority finances to know whether their deficits are reducing, or even if they are increasing. Spain's central government has targeted a deficit of 6.9 percent of GDP this year, with the rest of the adminstration being supposed to limit themselves to 2.4 percent to bring in the 9.3 total promised to the markets. <br /><br />So despite the fact that we only really have limited information at this point, here is how <a href="http://www.forexyard.com/en/news/Spains-Jan-Aug-govt-deficit-falls-more-than-40-pct-2010-09-27T114934Z-UPDATE-1">Reuters reported the news</a>.<br /><br /><blockquote>Spain's Jan-Aug govt deficit falls more than 40 pct<br /><br />* Deficit down 42.2 percent from same period last year<br /><br />* Higher tax take of 33.4 percent in period<br /><br />* VAT hike from July having effect<br /><br /><br />MADRID, Sept 27 (Reuters) - Spain's central government budget deficit fell more than 40 percent for January to August compared with the same period last year, thanks to a higher tax take, leaked data from the Economy Ministry showed on Monday.<br /><br />The January-August deficit, which does not include the balances of the social security system or provincial governments, would be equivalent to 3.3 percent of GDP.<br /><br />Spain has promised to cut the public deficit to 6 percent in 2011 and to an EU-guideline of 3 percent in 2013 -- forecasts many economists have said they doubt are possible in a low-growth environment.<br /><br />The central government deficit in the first eight months of the year totalled 34.85 billion euros ($46.50 billion), data from the ministry published on the website of financial newspaper Expansion showed. That was 42.2 percent lower than the same period last year.<br /><br />The improvement was helped by a 33.4 percent higher tax take, buoyed by a 2 percentage-point rise in value-added tax from July 1.<br /><br />Still, the January-August figure marks a smaller improvement than that logged in the January-July period, when the deficit came to 25.77 billion euros, down 48.2 percent from the same period last year. That data was welcomed by markets who saw signs that Spain was getting its fiscal house in order.</blockquote><br /><br />Now I am calling this the "official version", but I could, rather less charitably call it the "data engineered" one - since the people who are circulating it either don't understand how to read the official monthly updates on bugdet implementation, or they are intentionally trying to mislead. As I will try to show below, the sort of story being reported by Reuters represents a very tendentious reading on the numbers to say the least, since when you come to look at <strong>the fine print the real underlying deficit is not down over 40 percent from last year</strong>, <strong>the tax take is not up 33.4 percent on 2009</strong>, and the <strong>VAT increase is not having its effect (yet)</strong> since as the Agencia Tributaria (Spain's tax office) explain in their report, due to the August holiday period they haven't even processed the returns yet, and the only item they have data for is VAT paid on imports - which has brought in an estimated 100 million euros extra so far.<br /><br /><blockquote> "Julio y agosto recogen los primeros impactos recaudatorios de la subida de tipos, pero sólo en el IVA Importación, que se valoran en unos 100 millones (0,8% del incremento total)." Agencia Tributaria - August report.</blockquote><br /><br />So, what we have is not a lie, or even a damn lie, but it is a very studied and judicious use of the statistical data available. Put politely, the data we have been served seems specifically designed to confirm the idea that Spain is, finally, getting its fiscal house in order. Unfortunately, this is not the complete picture. What we are getting is the truth, and nothing but the truth, but what we aren't getting (yet) is the whole truth.<br /><br />As I say, the detail here, as always, is in the fine print, although the big point - that we don't know about regional government spending - really should be very obvious to anyone who is even vaguely aware that Spain is a fairly decentralised state, and thus it should stand out like a smoking gun that in all the articles you read about the deficit, the reference is to Spain's "central government" deficit, conveniently forgetting that a significant part of the total - and this year probably an even larger part than normal - comes from the regional governments and the municipal authorities - as <a href="http://spaineconomy.blogspot.com/2010/08/how-many-times-can-one-driver-fall.html">I have already tried to explain in this earlier post</a>. If we have leaned anything about Spain during the present crisis it surely is that nothing, but absolutley nothing that is to be found in a government press release should be accepted at face value without further checking. I don't think Spain's government simply blatantly and obviously falsifies its data, but I do think that data is often presented in a way which, if you don't follow all the methodological procedures which lie behind it, can give a totally misleading impression about what is going on, and I am not convinced that this outcome is completely unintentional.<br /><br />Luckily for us however, the body which is responsible for following the progress of the annual government budget as it is implemented - a very austere sounding entity known as the Intervención General de la Administración del Estado (or IGAE) - publishes a fairly readable and easy to understand monthly report (<a href="http://www.igae.pap.meh.es/sitios/igae/es-ES/InformesCuentas/Informes/Documents/Ind-2010/2010-08.pdf">latest issue available here</a>), and if more journalists who wish to report on Spain took the trouble to read and study it for themselves, then perhaps they wouldn't be so easily taken in by the latest government press handout as they evidently have been up to now.<br /><br />The first thing to note, as the IGAE themselves emphasise is that when it comes to following the annual execution of the budget it is important to compare like with like, and not, as it has become fashionable to say these days - apples with pears. In this case we need to distinguish between harmonised and non harmonised accounts. That is to say, when there has been a methodological change which influences the data the raw numbers (which you can find on page 9) can be very misleading, and you need to follow the harmonised data (which you can find in page 11). Thus, the raw data suggests that indirect taxes (impuestos indirectos) were up by 39.9% between January and August when compared with the previous year (seventh row, end column), while the harmonised (or adjusted) figure is 29.9% - meaning the real improvement is only 8.049 billion euros, and not 13.164 billion the raw number suggests.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgVTEMhHWv_sMPfzD9TzgAfaTxJ7WkZv8dL9Pcg1J6c34sAMI_6t8j2vTd9FctAjQBCRdmxNObt8eUDqR5rNHJi3-eaJ5jya33GvWnqtxYYlsS3-ktz7ybJkK-ZqNiEkr25eYsP1rMrFiI/s1600/Spain+Deficit+One.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 273px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgVTEMhHWv_sMPfzD9TzgAfaTxJ7WkZv8dL9Pcg1J6c34sAMI_6t8j2vTd9FctAjQBCRdmxNObt8eUDqR5rNHJi3-eaJ5jya33GvWnqtxYYlsS3-ktz7ybJkK-ZqNiEkr25eYsP1rMrFiI/s400/Spain+Deficit+One.png" alt="" id="BLOGGER_PHOTO_ID_5523788549230119250" border="0" /></a><br /><br />But even this is not the complete picture, since if we now go to the latest monthly report (<a href="http://www.aeat.es/AEAT/Estudios/Estadisticas/Informes_Estadisticos/Informes_mensuales_recaudacion_tributaria/2010/agosto2010.pdf">here</a>) from Spain's Agencia Tributaria (the tax office), we find (page 16 in the acrobat reader), that one of the big differences in the VAT numbers between 2009 and 2010 comes from the much smaller volume of refunds in 2010.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1Mgj1S-YjdkcjyQj-UxfrVJuRlPGyobHPsXrKYX5zx81yp1_MuLcolBpI-XqUpSMkDL7zQhwAs_oBXnDj7rDBmpn5s-QZPZX-0iIFSNaBoBX9d_o64m_2DZCWz5T-0cRqFL-DEQRPquw/s1600/Spain+Deficit+Two.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 250px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1Mgj1S-YjdkcjyQj-UxfrVJuRlPGyobHPsXrKYX5zx81yp1_MuLcolBpI-XqUpSMkDL7zQhwAs_oBXnDj7rDBmpn5s-QZPZX-0iIFSNaBoBX9d_o64m_2DZCWz5T-0cRqFL-DEQRPquw/s400/Spain+Deficit+Two.png" alt="" id="BLOGGER_PHOTO_ID_5523792123042499522" border="0" /></a><br /><br />Refunds fell from 43.525 billion euros in the first 8 months of 2009 to 33.087 billion in the same period of 2010, that is to say by 10.438 billion euros. In their methodological commentary the Agencia Tributaria (on page 5) put this reduction in refunds down to either money owing from previous fiscal exercises (4.4 billion euros) or refunds which had already been paid in 2009 (5.6 billion euros) due to a policy change which meant that refunds started to be made on a monthly basis. Be all that as it may, the real net increase in tax income from all sources so far this year is something like 6.9 percent according to the agency, and the net increase in IVA (adjusted for refunds) may be more like 5.4 percent, and not the splendid looking 47.5 percent figure which appears on page 11 of the IGAE report.<br /><br /><blockquote>Las devoluciones de IVA Anual 2009 caen hasta agosto un -60,9% (en consonancia con el menor importe solicitado), y las de IVA mensual apenas crecen un 0,3% porque las mayores devoluciones realizadas este año del ejercicio 2009 (por la generalización del sistema de devolución mensual) se compensan con el menor importe solicitado del ejercicio 2010. <span style="font-weight: bold;">La única novedad que aporta agosto en cuanto a los ingresos brutos es el IVA Importación</span>, que registra un aumento del 18,0% hasta este mes en sintonía con la marcha de las importaciones de terceros no energéticas. En total y antes de empezar arecoger el impacto total de la subida de tipos, el IVA bruto ya acumula un incremento del 5,4%. Agencia Tributaria Report, my emphasis.</blockquote><br /><br />Now, if we move over to the expenses side, we see that staff costs are up (2.3 percent) in the first eight months of the year, but this number is a little deceptive, since salaries were originally increased 3 percent in January of this year, and then cut in the May measures by an average of 5 percent as of 1 July, so evidently as the year advances the total increase should fall steadily, and may even arrive below zero by the end of the year. More importantly (for next year) freezing salaries for 2011 will represent a real reduction in salary 2011/2010 since the base to be applied on 1 January 2011 will be the level of 1 July 2010, which means during the year their will be a commensurate drop in Spanish domestic consumer demand.<br /><br />But the big reductions on the spending side for 2010 come in capital spending (infrastructure works etc) which is down 7.9 percent (or 500 million euros, about 0.05 percent of GDP), and in transfers to Spain's local authorities - which are down by around 1.3 billion euros (or about 0.13 percent of GDP). Transfers to the autonomous communities are in fact up, but interpreting this involves a complicated calculation, since there have been recent changes in the financing arrangements.<br /><br />On the other hand, Spain's regional governments, far from reducing their deficits are in fact increasing them like never before. In fact total autonomous community debt hit 104 billion euros (0r 10.4% of GDP) in June according to the latest Bank of Spain data, up from 82.9 billion one year earlier. That is to say, the regional governments increased their debt by nearly 25% year on year, and there is no sign so far that they are putting the brakes on.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg845xdh-MEAI4OuK0xr7JRXC3ydENYwXotY_64guOKPTRvf249OuMHmB-j3tX5Fxz4-rQ1LnuBjzY1xbMwWe1PDVGEsxV8S22citXTTSqS8kGogEeWoSpJ_LzsKcsC3M8VaGpvSyb45jI/s1600/Spain+Autonomous+Community+EDP+debt.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg845xdh-MEAI4OuK0xr7JRXC3ydENYwXotY_64guOKPTRvf249OuMHmB-j3tX5Fxz4-rQ1LnuBjzY1xbMwWe1PDVGEsxV8S22citXTTSqS8kGogEeWoSpJ_LzsKcsC3M8VaGpvSyb45jI/s400/Spain+Autonomous+Community+EDP+debt.png" alt="" id="BLOGGER_PHOTO_ID_5523803297738076690" border="0" /></a><br /><br />Of course, the regional governments only accounted for about 14% of last years deficit, so even if their deficit does shoot up, it won't be a determining factor, but it will make it much more difficult for the total deficit to fall within the targeted limits.<br /><br />The local authorities, on the other hand, have things a lot tougher, since their revenue from central government is significantly down, and they find it very hard to increase their borrowing from banks, so their rate of new debt accumulation is definitely slowing.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhmP1LQtARU_nGsSkpvAK2X4DwUxSCnTQqtYPeXkWJoDQP1ZUDcuAQIoYTZHLe_-iz2I1qrFsfMwO8oPTfqz_aDwomojOTsC_hFlIIYjBRfJTCRm7ij-Q6W4VnxwBM-ZiPkydm13oo31HU/s1600/Spain+Local+Authority+EDP+debt.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhmP1LQtARU_nGsSkpvAK2X4DwUxSCnTQqtYPeXkWJoDQP1ZUDcuAQIoYTZHLe_-iz2I1qrFsfMwO8oPTfqz_aDwomojOTsC_hFlIIYjBRfJTCRm7ij-Q6W4VnxwBM-ZiPkydm13oo31HU/s400/Spain+Local+Authority+EDP+debt.png" alt="" id="BLOGGER_PHOTO_ID_5523819932367180850" border="0" /></a><br /><br /><strong>Difficult Times Ahead For The Regional Governments</strong><br /><br />On 4 August 2010 Fitch Ratings placed four more Spanish autonomous communities on a Negative Rating Outlook, which effectively meant that all Spain's autonomous communities are now on Negative Outlook. According to the rating agency this move reflects their view that their budget balances will remain fragile in the medium term, while their debt will continue to increase. As they say, some indication of regional governmment intentions to curb expenditure have emerged, but in the majority of cases the measures still need to be detailed and implemented, a process which could take considerable time, and will certainly see us well beyond the 2010 fiscal exercise before their impact is felt. According to the terms of the recent Royal Decree the maximum deficit allowed for the Autonomous Communities during the 2010‐2012 period has been reduced by 0.5% of GDP. But this decision comes just one year after the Council for Fiscal and Financial Policy (CFFP) authorised the autonomous communities to exceptionally raise their deficits to 2.5% of the GDP for 2010, 1.7% for 2011 and 1.3% for 2012 in order to counterbalance the revenue shortfall being created by the crisis. So we can imagine some kind of chaos may well have ensued when those responsible for implementing their budgets learnt of the new targets.<br /><br />What is worse for the regional governments, as Fitch point out, the smaller deficit allowances introduced in June 2010 do not take into account the negative tax settlements related to excess transfers made by the state during 2008 and 2009 to try to help the beleagured regional governments. Although the amount of this excess funding temporarily transferred to autonomous communities by the central government has yet to be confirmed it is clear that now having reduced entitlement to funding will only make an already difficult position worse.<br /><br />What happened was that the 2008 and 2009 budgets’ tax forecasts were over‐optimistic and the autonomous communities received greater advance tax and sufficiency fund payments than warranted by the amounts actually collected, and the autonomous communities will now have to return the excess (see chart from Fitch below).<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEil4XiNy52eZm-RChe6RekpH7KMUOGDJy4WIc2WNjRrc0NQBy-J0QOu-5UvwioG28H8z-9cfpZIeHhmCCUV9YUl3VQ8CWcNWP0oIntqV-tI49HeScXOtdopOV49muAIkAdqqEYkcZAcqsk/s1600/Spain+Autonomous+Communities+Settlements+from+Previous+years.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 163px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEil4XiNy52eZm-RChe6RekpH7KMUOGDJy4WIc2WNjRrc0NQBy-J0QOu-5UvwioG28H8z-9cfpZIeHhmCCUV9YUl3VQ8CWcNWP0oIntqV-tI49HeScXOtdopOV49muAIkAdqqEYkcZAcqsk/s400/Spain+Autonomous+Communities+Settlements+from+Previous+years.png" alt="" id="BLOGGER_PHOTO_ID_5523827641475538194" border="0" /></a><br /><br />Fitch’s calculates that the excess allocated to autonomous communities in 2008 was something like 7 billion euros, and that in 2009 the number may have hit 21 billion euros. According to the new financing agreement with the central government, the regional governments can make repay in 60 monthly instalments starting in January 2011.<br /><br />Fitch is of the opinion that the increased financial pressure all this will produce plus the stricter control over debt authorisations introduced under the new financing agreement will definitely create heightened liquidity pressure for the regional administrations. Most of the autonomous communities have budgeted for a deficit equivalent to 2.4% of their GDP for 2010, however, since the central government is now only likely to authorise them to issue new debt equivalent to a maximum of 1.95% of GDP, they will have to fund a gap equivalent to a minimum of 0.45% of GDP without new borrowing. The most likely scenario is that their cash reserves will decline and that delays in paying suppliers will increase.<br /><br />In fact only this week, <a href="http://www.economist.com/node/17155786?story_id=17155786&fsrc=rss">the Economist quotes Juan Bravo</a>, who is in charge of finances for the city of Madrid, as saying that the city’s income will not return to 2007 levels until 2016, and in the meantime the only way he can survive is to delay payment. “Last year I paid bills in 60 days, now I am paying in six or seven months,” he said. (Or see <a href="http://online.wsj.com/article/BT-CO-20101003-703628.html">this report in the WSJ</a>)<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_wThz8QVcBFnSnPa803O3o6zEOzIyPXoW7VaU9vwGWaTDFie-smogc-rr70Thbe7LzYpPRDssg9uQNIx6LarD8BHhPRbygVd1jko3FtW_W2Kgr_hsYikJ87XYn5PHMh3veb2E9LsUX9w/s1600/spain+accounts+eight+english+version.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_wThz8QVcBFnSnPa803O3o6zEOzIyPXoW7VaU9vwGWaTDFie-smogc-rr70Thbe7LzYpPRDssg9uQNIx6LarD8BHhPRbygVd1jko3FtW_W2Kgr_hsYikJ87XYn5PHMh3veb2E9LsUX9w/s400/spain+accounts+eight+english+version.png" alt="" id="BLOGGER_PHOTO_ID_5523829397728867026" border="0" /></a><br /><br />And to make matters worse, significant doubt exists about the achievability of Spain's GDP growth forecasts. Finance Minister Elena Salgado said last Friday that she was confident the country's economy would grow in line with government forecasts but most analysts feel the forecasts of a 0.3% contraction this year,followed by growth of 1.3% in 2011, 2.5% in 2012 and 2.7% in 2013 are far too optimistic.<br /><br />The bottom line here is that Spain's real commitment to meet its targets is still on trial. Pressure from financial markets may well mean that the fiscal effort made in the second half of the year will be much greater than that in the first, but all in all, achieving the 6% target for 2011 looks to be an extraordinarily difficult task, given everything we have seen so far. As one investor put it recently “We are still skeptical as to whether they will really take all the austerity measures or only go as far as the market forces them, and when pressure abates they’ll let the deficit slip again. It seems they want to do as little as needed to relax the markets.”<br /><br />And, of course, if all this wasn't enough, even if the fiscal effort is made as the government is promising, this still doesn't solve the deep-seated underlying problem. Just what is the plan to put sufficient dynamism back into the Spanish economy in order to produce those lovely growth numbers that we would all so much like to see?Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-37107102359139107122010-10-03T00:00:00.000-07:002010-10-03T01:21:54.053-07:00Bubble Trouble In Finland?by Edward Hugh: Barcelona<br /><br />According to <a href="http://www.bloomberg.com/news/2010-08-18/nordic-economies-risk-housing-market-collapse-that-may-trigger-recessions.html">an intriguing article I read in Bloomberg recently</a> an alert signal has been sounded due to the fact that house prices in the Scandinavian countries have been rising very rapidly of late. Judging by what they explain what is now going on in the housing markets of Norway, Sweden and Finland would seem to have all the hallmarks of a "mini-bubble", one which is all the more perplexing given the lowish level of economic activity which characterises the current environment. But then I asked myself, and those whopping German export numbers we saw in the second quarter, wheren't they also some kind of "mini bubble" which was quite out of keeping with what we should expect to be seeing.<br /><br />Worse, if this seeming Scaninavian bubble were to pop, it could well send what has up to now been among the strongest regional rebounds on the whole European continent straight into a nosedive. In particular the Finnish problem interests me, house prices are rising steadily, and with them construction activity, even as the economy in general remains severely depressed following one of the sharpest output falls to be found in the Eurozone.<br /><br />The central cause of the problem is not hard to pin down, it is to be found the widespread recourse to variable rate mortgages, which make activity in the housing sector (and through it the economy as a whole) highly sensitive to short term movements in interest rates . About 95 percent of mortgages in Finland and Norway follow money-market levels, while about 60 percent of Swedish loans are based on adjustable rates. This exposure to variable rates mirrors closely the situation in Spain and compares with that in Germany where some 90 percent of homeowners make fixed interest payments, or in France where the percentage of fixed rate mortgages is slightly less than in Germany but substantial nonetheless. Really I'm rather surprised that more of the experts on our financial systems haven't made this variable rate boom/bust behaviour connection during the recent debate.<br /><br />Anyway what this flexible rate exposure means is that last the record low borrowing costs which are available in European money markets have simply fed straight into the Nordic region housing markets - where householders were not so deeply leveraged going into the crisis as they were in Spain or Ireland - and it has done so much faster than in it has in other parts of Europe. France would be the other country to watch (or Poland) but at least in France the central bank has a better hold on the situation via the insistence on a fixed rate mortgages policy.<br /><br />And the situation is not to be laughed at: Bloomberg quote Finnish Finance Minister Jyrki Katainen as saying he is "very worried" since in his opinion “There could be a housing bubble in the making in Finland. There is a risk that mortgage borrowing costs are too low.” My feeling is that by the time Finance Ministers start talking about the problem it is already too late.<br /><br />So, with my curiousity piqued, I duly went over to the Finnish central bank website where I found the following:<br /><blockquote><br />"Households’ new drawdowns of housing loans amounted to EUR 1.5 billion in August, up by 1% on July 2010 and 20% on August 2009. The average interest rate on new housing-loan drawdowns rose to 2.08% in August, from 2.03% in July. A typical housing loan drawn down in August was tied to a 12-month EURIBOR and had a maturity of 20 years. The stock of MFI housing loans to households grew by EUR 0.4 billion on July, to EUR 75.0 billion at end-August. The annual growth rate of the housing loan stock slowed to 6.7%, from 6.8% in July. The average interest rate on the stock of housing loans rose by 0.02 percentage point from July, to 1.96%". </blockquote>So it is true, interest rates in Finland are ultra cheap (around 2%) and the stock of mortgages is rising by nearly 7% annually: not ulta high by historic standards, but we are in the midst of, well you know. Which takes me back <a href="http://spaineconomy.blogspot.com/2010/10/all-for-one-and-one-for-all-we-arethe.html">to my last post on imbalances in the Eurozone</a>, and what the ECB can do to prevent a situation like the one in Finland becoming a repeat performance of what happened in Spain or Ireland.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjANSqkV-k4qg5fB46PJolIiXnKYpX-RoEG5jDCtYham0U7WEG7dmY2OUel6bRME6_3tQ7oVgS0UqvecgKVW4Om201K-ab9DA8wAgD0TFy4iI1gLz6507bg21SxdiGNc3pJw2R554TFy6HC/s1600/Finland+Bank+Lending+For+Household+Mortgages.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjANSqkV-k4qg5fB46PJolIiXnKYpX-RoEG5jDCtYham0U7WEG7dmY2OUel6bRME6_3tQ7oVgS0UqvecgKVW4Om201K-ab9DA8wAgD0TFy4iI1gLz6507bg21SxdiGNc3pJw2R554TFy6HC/s400/Finland+Bank+Lending+For+Household+Mortgages.png" alt="" id="BLOGGER_PHOTO_ID_5523492285504484802" border="0" /></a><br /><br />In Finland, existing flat prices rose by an annual 10 percent in the second quarter, after surging a record 11.4 percent in the first three months of the year. In Greater Helsinki the growth rate was 13.6 percent and in the rest of the country 7.0 percent.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgnORpUV8WrTX9fxPJ2Y5HQYr0RKfsc7nJDZva5QbW3HE8ZaX5b5Q5stbomYzgFVCisIRuilZQUuKtYs-wkFsc7_ZzngXseDW6_smT175WyTV-ZrC0fcNutk2JvmlZNz8ByTJJCzJgR8Grr/s1600/Finland+Flat+Prices.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 233px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgnORpUV8WrTX9fxPJ2Y5HQYr0RKfsc7nJDZva5QbW3HE8ZaX5b5Q5stbomYzgFVCisIRuilZQUuKtYs-wkFsc7_ZzngXseDW6_smT175WyTV-ZrC0fcNutk2JvmlZNz8ByTJJCzJgR8Grr/s400/Finland+Flat+Prices.png" alt="" id="BLOGGER_PHOTO_ID_5523516959660516274" border="0" /></a><br /><br />The situation with house prices is similar, since after a 1.5% fall in 2009 (with the price in large urban areas falling by as much as 8.7 percent they are now back back on their way up again.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhVppDClr84Ne3xWf1YHy3ijog0SuJLSg3bCoIX39Ea_T34ylE774k07Vcja00NFJfW_GCHu3LjvmOY4JNVCm2PsMNF8eciAdwWm8AP8WWPVfXzTjUgYls6CEZGRWK1SxHRsxORvR3efiMp/s1600/Finland+detached+house+prices.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 256px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhVppDClr84Ne3xWf1YHy3ijog0SuJLSg3bCoIX39Ea_T34ylE774k07Vcja00NFJfW_GCHu3LjvmOY4JNVCm2PsMNF8eciAdwWm8AP8WWPVfXzTjUgYls6CEZGRWK1SxHRsxORvR3efiMp/s400/Finland+detached+house+prices.png" alt="" id="BLOGGER_PHOTO_ID_5523519532165570674" border="0" /></a><br /><br />And the pressure is mounting, since household debt in Finland rose to 107 percent of disposable income at the end of last year - up from 65 percent in 2000. Which means that any significant rise in interest rates at the ECB could see many of those with mortgages having difficulties maintaining their monthly payments.<br /><br />What is even more curious is that all of this is taking place even while the Finish economy is a long way from emerging from the deep hole into which it fell. Finland’s GDP is expected to grow by 1.5 this year, following last years 8 percent contraction, according to a government forecast which does not seem totally unrealistic. But if we look at the chart below, which shows the GDP indicator produced by the Finnish statistics office, there is still a very, very long way to go to get back to where we were.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhEYmak6YchGN1rgv4rFY_gzM77nNmCRiM5xZWyHbwGNb5JwHLe3TXaZyFmcWL_NiPg3YYJoEm8n-WabWWfo0FQGZbdDDgobk_o_dhco0Ge8yx0T2cZ1sZjkLZItwMByHMRXKj0LAQ3ovtA/s1600/finland+GDP+indicator.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 230px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhEYmak6YchGN1rgv4rFY_gzM77nNmCRiM5xZWyHbwGNb5JwHLe3TXaZyFmcWL_NiPg3YYJoEm8n-WabWWfo0FQGZbdDDgobk_o_dhco0Ge8yx0T2cZ1sZjkLZItwMByHMRXKj0LAQ3ovtA/s400/finland+GDP+indicator.png" alt="" id="BLOGGER_PHOTO_ID_5523501427519711618" border="0" /></a><br /><br />Yet despite this, consumer confidence is at what are effectively record levels.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQ0DLGpfq9TVKAl-aCTUM0XeX2h8_Im-oFhbA9gI2DP6M-0xkxwPljZlBreHQIvUWV3oe2Gdaq1W-Ett13n0XLHlBC5C6uX3A2P0k8id1eWWK5Ndz3lIbOntM3-B72pTRvQE3cni9U5npe/s1600/consumer+confidence.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 261px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQ0DLGpfq9TVKAl-aCTUM0XeX2h8_Im-oFhbA9gI2DP6M-0xkxwPljZlBreHQIvUWV3oe2Gdaq1W-Ett13n0XLHlBC5C6uX3A2P0k8id1eWWK5Ndz3lIbOntM3-B72pTRvQE3cni9U5npe/s400/consumer+confidence.png" alt="" id="BLOGGER_PHOTO_ID_5523542856250907842" border="0" /></a>So with all this money going into construction and consumption the Finnish economy is starting to suffer from structural distortions (heard about that before somewhere, have we?).<br /><br />Retail sales have more or less recovered, and are now steadily moving above their pre crisis level.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqWWO0q1t4HwgnmgLlrts7q6b2zpyRvBR_ROA6fNGiY1T7NDf8dmkx5SDyML0K8NXByShLdiz-4mDRKt1QCScQOxLw9LBhXQ57sjLBEaoVDfpHDwj1VHAq0gJ04-o75xqB99mtxYGnvBpI/s1600/finland+retail+sales+two.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqWWO0q1t4HwgnmgLlrts7q6b2zpyRvBR_ROA6fNGiY1T7NDf8dmkx5SDyML0K8NXByShLdiz-4mDRKt1QCScQOxLw9LBhXQ57sjLBEaoVDfpHDwj1VHAq0gJ04-o75xqB99mtxYGnvBpI/s400/finland+retail+sales+two.png" alt="" id="BLOGGER_PHOTO_ID_5523543770320978754" border="0" /></a><br />But industrial output is remains way down (in July it was still 23 percent from peak, and even showing signs of falling back).<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhobiIrxxnxwQxYritYgl1r0IsbWwDsAb9Mhc7SyJZMYq8O14ZRcSCFC6b_9NQrOG9FE6PvNl5CK6OD92ZsuPGW5aCq4a8JYTksijMRTi4QP5v-q8qUksTzJuQhq47I-IOKF6uaANHVsCfz/s1600/finland+IP+two.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 197px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhobiIrxxnxwQxYritYgl1r0IsbWwDsAb9Mhc7SyJZMYq8O14ZRcSCFC6b_9NQrOG9FE6PvNl5CK6OD92ZsuPGW5aCq4a8JYTksijMRTi4QP5v-q8qUksTzJuQhq47I-IOKF6uaANHVsCfz/s400/finland+IP+two.png" alt="" id="BLOGGER_PHOTO_ID_5523521093088827154" border="0" /></a>And Finnish exports have completely failed to recover.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhdOeDXXilT-fhi1PQmN6X3SdCEVd-HWg3fQftNaE0H5rOG-fPnOoRuNhLOfh3JEU7IxBvJqELXt9g78rUjSoJga6gJv2Pnvjz4N4SSSoFooOXt11e2C7kF19HVNVfnlRGV-ugCg4pg856o/s1600/finland+exports+one.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 234px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhdOeDXXilT-fhi1PQmN6X3SdCEVd-HWg3fQftNaE0H5rOG-fPnOoRuNhLOfh3JEU7IxBvJqELXt9g78rUjSoJga6gJv2Pnvjz4N4SSSoFooOXt11e2C7kF19HVNVfnlRGV-ugCg4pg856o/s400/finland+exports+one.png" alt="" id="BLOGGER_PHOTO_ID_5523523857791557570" border="0" /></a>A feature which is very clearly reflected in the trade balance, which is now very near to turning negative. Competitiveness problem anyone?<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh1jM5Y7nbbOXi6XqgiHiYze1mt5eD57DZhpvKbre1ZvQ-TP844zixN0GPbRHq4eCom2-b_l8FF-t0gxt0BwVxpp3BB6gl3OvJ2P42yHgw42cI6cEjpZrai8xjO7ptZUeVHCSZtXcqTVWqV/s1600/Finland+Trade+Balance.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 232px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh1jM5Y7nbbOXi6XqgiHiYze1mt5eD57DZhpvKbre1ZvQ-TP844zixN0GPbRHq4eCom2-b_l8FF-t0gxt0BwVxpp3BB6gl3OvJ2P42yHgw42cI6cEjpZrai8xjO7ptZUeVHCSZtXcqTVWqV/s400/Finland+Trade+Balance.png" alt="" id="BLOGGER_PHOTO_ID_5523523707768226882" border="0" /></a>What is quite surprising is that while Finnish industry did pretty well at maintaining its price competitiveness up to 2007 (if we look at the REER chart below), it seems to have losy considerable ground in 2008 and 2009 (ie during the crisis, which seems to suggest "rigidity" rather than "flexibility"), and, of course, (to repeat the old mantra) it can no longer devalue to make an "easy" correction. So it looks like it is going to have to follow its Baltic neighbours down the hard road of a long slow internal devaluation, and especially after the bubble bursts.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhbhgYVPP1L_5xO3eeBpNesZHYgH5FXMwQ6mvVtptveyu58LDP7dsKjD_X99ttrrgcIwz3n9E8bsbyNL1IUWJtSaVSAkWnl9u8ycxDg0StaNKwCSjt4mru8GzABeTGc3Cx_wqvPd1gmExXh/s1600/Germany+and+Finland+REER.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 202px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhbhgYVPP1L_5xO3eeBpNesZHYgH5FXMwQ6mvVtptveyu58LDP7dsKjD_X99ttrrgcIwz3n9E8bsbyNL1IUWJtSaVSAkWnl9u8ycxDg0StaNKwCSjt4mru8GzABeTGc3Cx_wqvPd1gmExXh/s400/Germany+and+Finland+REER.png" alt="" id="BLOGGER_PHOTO_ID_5523527396892175986" border="0" /></a><br /><br />Of course, as others have already pointed out, this isn't simply a Euro problem, since neither Sweden or Norway are in the Euro, and they are also struggling to contain their housing markets. They are typical problems faced by a small open economy in an environment of massive external liquidity. Evidently, as Roubini Global's Mikko Forss says, tighter regulation from the Bank of Finland would have helped (I fear it is now really too late for this to be effective in the timeframe available) - controlling loan to value ratios, limiting variable rate mortgages, raising income-to-loan parameters, etc. As things stand, the main short-term threat to Finland would seem to come more from a premature raising of rates - which would surely burst the thing - rather than from keeping interest rates lower longer, and trying to implement some emergency measures.<br /><br />Obviously it is hard to convince a country which has just had such a sharp drop in output that even a 3.8% fiscal deficit is too high in a situation where consumer credit demand is leading the economy to become increasingly distorted, but if its pain you are worried about, then maybe a short term dose is a lot better than ending up where Spain and Ireland are. Without monetary policy tools available all the authorities can do is impose regulations and use their own fiscal spending to regulate demand. And inflation expectations and credit demand are both on their way up. According to the September consumer confidence survey, Fins expect consumer prices to increase by 2.6 per cent over the next 12 months. One year ago the predicted inflation rate was 1.6 per cent, and its long-term average is 2.1 per cent. And when asked about their borrowing intentions, 71 per cent of those questioned stated they thought this was a good time to raise a loan, while in August the proportion was 64 per cent. Hardly a surprising result, with interest rates pinned to the floor, and inflation expectations rising.<br /><br /><br />So the Finnish economy does seem to be poised on the edge of some sort of cliff, and one day or another it is likely to fall. And it is precisely the existence of problems like these in a country like Finland (far from the Mediterranean beaches and sun) which leads me when thinking about the problems we have on our hands to prefer the expression Europe's periphery (from Ireland to Finland to Latvia to Hungary to Bulgaria to Slovenia to Greece and Spain and Portugal) rather than the over narrowly-focused (and somewhat abusive) term PIGS. But whichever way you look at it, and whatever you want to call them, there are a growing number of countries inside the EU who face mounting rather than subsiding problems at this point.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-10660991115441813822010-10-02T08:12:00.000-07:002010-10-02T08:29:21.143-07:00All For One And One For All - "We AreThe Eurozone"One of the worrying things about the handling of the current European crisis is how many of those responsible for taking the decisions seem to view the Eurozone in a way which is every bit as rigid, timeless and dogmatic as the thinking of those old school scholastics whom Galileo, in his time, found himself battling against. Rather than facilitating a dialogue, and a free and open discussion, the guardians of fortress euro seem to want to keep the doors slammed tight shut, just in case any strange and unwanted ideas should inadvertantly slip in without them noticing.<br /><br />Take the issue of Eurozone aggregate data. Treating the countries that constitute the bloc as one homogenous entity seems to have become a sort of shibboleth which it is impossible to question, even though it is patently evident to all concerned that there are often enormous differences between the economy of one member country and another. Inflation is the prime example. What seems to interest members of the ECB Governing Council when they have their monthly meeting is that somewhat abstract entity, the average EU16 inflation rate, while what is obviously interesting to follow from a policy point of view (just look what happened to Ireland, Spain and Greece in the years before the crisis - see Spain chart below), is the degree to which inflation rates in individual countries diverge from the mean.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjIFzxF0GTczzsrcbh4r8FtAah_hIKFNnKOwYQaQ6SxYWRNOw4K2kTYkTu8TYS6HlEiNzStxoHPAsahY-Yvo8SarmOr-FL70PMysZayPlAqSByqoxwWwTmePTyzFnQ92ITQttrniqRi-6ms/s1600/CPI+and+ECB+interest+rates.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 255px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjIFzxF0GTczzsrcbh4r8FtAah_hIKFNnKOwYQaQ6SxYWRNOw4K2kTYkTu8TYS6HlEiNzStxoHPAsahY-Yvo8SarmOr-FL70PMysZayPlAqSByqoxwWwTmePTyzFnQ92ITQttrniqRi-6ms/s400/CPI+and+ECB+interest+rates.png" alt="" id="BLOGGER_PHOTO_ID_5523419620835373554" border="0" /></a><br /><br />Another example would be current account balances (see chart below). Eurostat publishes data for the EuroArea 16 on a monthly basis, but I think I am right in saying they never publish the national-level breakdown (certainly I have never seen it, and that hasn't been for want of trying). But, of course, now we find ourselves with a whopping set of internal imbalances between those countries running large surpluses and those with large deficits - which the financial markets are becoming less and less willing to fund - and no one seems any too clear about what to do to restore the balance. But how were the imbalances allowed to build up in the first place? Did they creep up on us by stealth, or was no one really looking?<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWHrDxcfR0NAFVODvOLNBX0rtyUjIDTXUV2bTKfl1nvU8OwXj39tIdbuGIgip0ZtI9NI98p0sOr4e4Nv49w-QNEcdUTfx7YhrcJ_nR52JRvFeM22MTXSnZPnJKx-YBFyAd1HCAmOvhPZGe/s1600/CA+Balances.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 211px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiWHrDxcfR0NAFVODvOLNBX0rtyUjIDTXUV2bTKfl1nvU8OwXj39tIdbuGIgip0ZtI9NI98p0sOr4e4Nv49w-QNEcdUTfx7YhrcJ_nR52JRvFeM22MTXSnZPnJKx-YBFyAd1HCAmOvhPZGe/s400/CA+Balances.png" alt="" id="BLOGGER_PHOTO_ID_5523457463268218258" border="0" /></a><br /><br />Exactly the same issue arises with the national breakdown of bank borrowing from the ECB. As if living in a theoretical cocoon, decision makers at the ECB move forward in way which makes them seem completely impervious to the problems posed by the way banks in one country are more dependent on funding than are those in others (M Trichet repeatedly refuses to answer questions on this kind of issue at the monthly press conference) and hence remain walled-in from the issues which actually exist in the real world which surrounds them. When pressed they simply state that there is no problem since an EU country is in principle just like a US state - try telling that to Ireland or Greece. Or try telling it to German voters when they are asked to contribute to bailouts.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhEEAieUPIfXvv1AnUrgaBZZPdh397V-YW03VtAhDmjIgO0af_2LhYyAlURyq0CStWt2K3H0_SpswwKWMXB7sH97CFoNQlpiHsiVPP-d2lKWobtHXqWizxtmBL-N8woVwX5R2vgq2c9iPlS/s1600/Country+Bank+Dependency.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 258px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhEEAieUPIfXvv1AnUrgaBZZPdh397V-YW03VtAhDmjIgO0af_2LhYyAlURyq0CStWt2K3H0_SpswwKWMXB7sH97CFoNQlpiHsiVPP-d2lKWobtHXqWizxtmBL-N8woVwX5R2vgq2c9iPlS/s400/Country+Bank+Dependency.png" alt="" id="BLOGGER_PHOTO_ID_5523424477077279090" border="0" /></a><br /><br />The issue is of course a very telling one, since basically the whole present Eurozone debt crisis has the inter-country imbalances as its backdrop, hard as the members of the ECB Governing Council may try to avoid admitting it, prefering instead to focus attention on the fiscal profligacy (of which, naturally, there has been a good deal) of the national members state governments. In other words, the problem is not of their making, oh deary me no!<br /><br /><strong>Rivers Of Liquidity Here, Credit Drought There</strong><br /><br />National divergences in bank lending constitute another very good case in point. Despite the fact that the current crisis has become known as a Sovereign Debt One, it isn't always fiscal spending and public sector debt which lies at the heart of the problem. In fact, private sector debt is often as much of an issue, and the private sector in some EuroArea countries is heavily indebted, while that in others is not. It is important to discover who is who here, and to distinguish between them, since if you don't it will be impossible to decide prescisely which kind of policy mix is appropriate in each and every case (but, of course, our modern scholastic dogmatists will tell us there are no such things as "cases" here, and continue to insist there should be no distinction between countries at the level of policy). Yet just when you need the fine grained detail, what you get are more aggregate numbers and a bunch of platitudes which really tell you very little.<br /><br />Thus, in the August edition of their publication "<a href="http://www.ecb.int/press/pdf/md/md1008.pdf">Monetary Developments In The Euro Area</a>" we learn from the ECB that bank lending to euro-zone businesses increased in August by €17 billion as compared with July, a rise which more than reversed the €11 billion decline in July over June. What this increase meant was that the annual rate of <strong>decline</strong> in corporate borrowing was only 1.1% in August versus a 1.4% annual drop in July. That lending to corporates is <strong>falling less rapidly</strong> is good news, but it is still falling on an annual basis.<br /><br />Aggregate lending to households also picked up, rising €14 billion during August compared with a €5 billion monthly increase in July. This lead the annual rate of growth to rise to 2.9% from 2.7% in the previous month, which produced a lot of "at last" type comments in the press. And putting the two numbers together, we find the annual rate of growth in loans to the entire private sector was up at 1.2% in August from 0.8% in July. Relief all round, surely, since we are going the right way.<br /><br />Unfortunately nothing is ever so simple, and once we start to dig down we find large and significant disparities - disparities which may well produce monetary policy decision conflicts for the ECB in the months to come - hidden away in the aggregates. In France, for example, lending for house purchases was up an annual 6.5% in August, and indeed over the last three months such lending rose at a 7.9% annualised rate (ie lending growth for housing is accelerating), while in Spain total house lending was only up 0.6% on the year (in July, we don't have the August data from the bank of Spain yet, but it won't be very different).<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEig80UVBwNYksXya_gHXdDeHmKhyphenhyphen1JDX4vDBQGDCCJWm8krGCDgxEg3iyRwlBU5t1EFIL-nlCOC20LK-6It8BXUmaTaF9GUMYmBAR8VCx2brIEvGd9Haf2ojDZHPb2fXxk6uFKe64assgbh/s1600/France+Mortgage+Lending+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 245px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEig80UVBwNYksXya_gHXdDeHmKhyphenhyphen1JDX4vDBQGDCCJWm8krGCDgxEg3iyRwlBU5t1EFIL-nlCOC20LK-6It8BXUmaTaF9GUMYmBAR8VCx2brIEvGd9Haf2ojDZHPb2fXxk6uFKe64assgbh/s400/France+Mortgage+Lending+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5523431204654967250" border="0" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi3HkbS20lpz8nht8uoamrUo6MamiVKy4R4JTCNqkejhx3gco-5-hZVcQx2_wqJlHgDuyy8S9yOQMvcza52LX4FGRdFDOau-s5h7vJ_mEWbkdjASBr4-h9sIjFzHgVBkBwuhdKHVdjqd-Gq/s1600/Spain+bank+lending+for+house+purchases+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi3HkbS20lpz8nht8uoamrUo6MamiVKy4R4JTCNqkejhx3gco-5-hZVcQx2_wqJlHgDuyy8S9yOQMvcza52LX4FGRdFDOau-s5h7vJ_mEWbkdjASBr4-h9sIjFzHgVBkBwuhdKHVdjqd-Gq/s400/Spain+bank+lending+for+house+purchases+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5523431340982815602" border="0" /></a><br /><br /><br />When we come to total lending to households we find the pattern repeated, since this was up 5.4% in France in August, and only 0.5% (in July) in Spain.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjbDnvYP8-Ecw-OtOKYXG1bcjbuohspY8RqiPX_7CpFbKO_1xWEqHmC-5fkPxxbXeLTDO9SDkIvHOm62Tnxd2XZejkyib07qnrlbOnBKelX-Ib04SiOfXVa-VWMX9vRW748J-8chwh6AVH4/s1600/Frnace+Bank+Lending+To+Households+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 241px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjbDnvYP8-Ecw-OtOKYXG1bcjbuohspY8RqiPX_7CpFbKO_1xWEqHmC-5fkPxxbXeLTDO9SDkIvHOm62Tnxd2XZejkyib07qnrlbOnBKelX-Ib04SiOfXVa-VWMX9vRW748J-8chwh6AVH4/s400/Frnace+Bank+Lending+To+Households+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5523431948892852818" border="0" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEguQbJJm2Bz9YhLetnOVYiDk6wvmSJa68_cQYalS9Ai6nUrr1XFzQYUssdpeBb-ymLrx8kPN7iXAKV0A_INDJj-gWmyOF8L8roxa-Q50UOOLcnNE5bMCgnS7ENJu72C7gxHMYkr2iG3xUsa/s1600/spain+bank+lending+to+households.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 241px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEguQbJJm2Bz9YhLetnOVYiDk6wvmSJa68_cQYalS9Ai6nUrr1XFzQYUssdpeBb-ymLrx8kPN7iXAKV0A_INDJj-gWmyOF8L8roxa-Q50UOOLcnNE5bMCgnS7ENJu72C7gxHMYkr2iG3xUsa/s400/spain+bank+lending+to+households.png" alt="" id="BLOGGER_PHOTO_ID_5523431789117870722" border="0" /></a><br /><br />And when we come to corporate borrowing, this was <strong>up</strong> an annual 0.4% in France in August, while it was <strong>down</strong> 1.9% in Spain (in July).<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjlwc2VGuC9LQuFeBa1VcOG-DJSTOAmxFF3J2HYsfMyJMnimiJpowv21VaeoxZ5zfn8f0ul_7QNoMhoUGBy7SiUsctX5Dh9XxBnx5m3lCJsnx9iLIX6eZOrRmAmikssnfbdTImF8Jg4_igU/s1600/France+Corporate+Lending+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 247px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjlwc2VGuC9LQuFeBa1VcOG-DJSTOAmxFF3J2HYsfMyJMnimiJpowv21VaeoxZ5zfn8f0ul_7QNoMhoUGBy7SiUsctX5Dh9XxBnx5m3lCJsnx9iLIX6eZOrRmAmikssnfbdTImF8Jg4_igU/s400/France+Corporate+Lending+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5523432426925264818" border="0" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhl8SXBxoMCgLxZCb2ZZ7G_qPnFbZK57lyejJQyMCQqOys49t2w7XhmcJ_zQCCftALIRULKDrBancAy6ib_ouz4ksUc0edZYx2aRHwtyrogi66SX7y54jcw-gZwoUG0s2IhkS0yWVuabcct/s1600/Spain+Bank+Lending+to+Corporates+YOY.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 239px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhl8SXBxoMCgLxZCb2ZZ7G_qPnFbZK57lyejJQyMCQqOys49t2w7XhmcJ_zQCCftALIRULKDrBancAy6ib_ouz4ksUc0edZYx2aRHwtyrogi66SX7y54jcw-gZwoUG0s2IhkS0yWVuabcct/s400/Spain+Bank+Lending+to+Corporates+YOY.png" alt="" id="BLOGGER_PHOTO_ID_5523432624845386290" border="0" /></a><br /><br />But then, you may want to ask, at the end of the day just why would anyone in Spain want to take on more debt? Since the Spanish stock of corporate debt is around 1,300 billion euros, while the French equivalent is only 771 billion euros (and the country is about half as big again as Spain), French corporates could certainly take on some more debt (if circumstances like market and investment needs warranted) but Spain's heavily over-indebted corporates simply need to pay their debt down. In the context of Spain's shrinking economy, more credit for Spanish corporates simply means more indebtedness and more interest-roll-up loans of the kind that "gather no loss" (at least at the balance sheet level), hardly a desireable development at this point.<br /><br />Evidently I have taken the two polar cases here, borrowing in Italy and Germany is much weaker than in France, while the situation in Ireland, Greece and Portugal will look more like Spain. But this is part of the point, France is the one large EuroArea country where domestic demand still has real life to it (for a variety of reasons it wasn't blown out by a bubble during the last round) but for just that very reason it would be absolute madness to turn the goose that can still lay golden eggs into some kind of "foie gras" by feeding it up with massive doses of liquidity it evidently doesn't need.<br /><br />Looking at the inflation differential between France and the Eurozone average matters aren't getting out of hand yet, although French inflation is above the average in a way in which it has not been before, and the situation now requires careful monitoring.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiVRPux4NXIcjw6KDbxRxc3zC_JvYNJOWYtWyevRMsSz4mMTKz23DdNl9bxXzjCr31hDSwNGyVT1pC92y4Ix8prQwevT08WtgISAELmXbofQ46FVbUpr4uRK2p0t2LoBN6Bf8Q3Ncq7Q_bT/s1600/france+and+eurozone+cpi+two.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiVRPux4NXIcjw6KDbxRxc3zC_JvYNJOWYtWyevRMsSz4mMTKz23DdNl9bxXzjCr31hDSwNGyVT1pC92y4Ix8prQwevT08WtgISAELmXbofQ46FVbUpr4uRK2p0t2LoBN6Bf8Q3Ncq7Q_bT/s400/france+and+eurozone+cpi+two.png" alt="" id="BLOGGER_PHOTO_ID_5523445718971121810" border="0" /></a><br /><br />Forward looking inflation expectations have risen in France in recent months, but they seem to a stagnated of late, so again, at this point there is no need to panic.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgJjy2OHexA7EX074nwiWvtu0lujq605bJIcfAc0C5usIBBOpAtQLDqiAPCnYGg-FV2v752okLMfzspotg1XPTjXs0HswbESg80glo54J4mT6Vn0qdMF1SuB_ZshTWwDySAj5ktAzVoNuQ/s1600/France+Inflation+Expectations.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 215px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgJjy2OHexA7EX074nwiWvtu0lujq605bJIcfAc0C5usIBBOpAtQLDqiAPCnYGg-FV2v752okLMfzspotg1XPTjXs0HswbESg80glo54J4mT6Vn0qdMF1SuB_ZshTWwDySAj5ktAzVoNuQ/s400/France+Inflation+Expectations.png" alt="" id="BLOGGER_PHOTO_ID_5523445872304071378" border="0" /></a><br /><br />But the situation is one where - now what is the expression - "extreme vigilance" needs to be exercised, since naturally there is no reason why a country that didn't have a bubble last time round won't develop one next time. So perhaps one of you journalists who attend the post-meeting press conference might like to ask M Trichet whether this is the kind of approach he has in mind, and what policy options are open to him should the worst case scenario (on the upside) really start to materialise. In the meantime, all I can do is shrug my shoulders and mutter under my breath "ma eppur si muove".Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-44741049733529151372010-09-27T03:15:00.000-07:002010-09-27T22:43:01.191-07:00And Then There Were Noneby Edward Hugh: Barcelona<br /><br />According to Spanish Prime Minister José Luis Rodríguez Zapatero <a href="http://online.wsj.com/article/SB10001424052748704129204575506182829904198.html">speaking in an interview with the Wall Street Journal last Tuesday</a> the European sovereign debt crisis is over. "I believe that the debt crisis affecting Spain, and the euro zone in general, has passed," Mr. Zapatero said.<br /><br />This is excellent news, but it comes with just one proviso, and that is that despite all such reassurances most financial market participants seem to be far from convinced that he is right. True Spain recently raised nearly €4bn in a successful government bond sale, with <a href="http://www.reuters.com/article/idUSLDE68F11Q20100916">some observers suggesting</a> the sale constituted but one more sign that what is still the eurozone’s fourth-largest economy had finally broken free from the group of “peripheral” European economies who have severe economic problems and whose debt is viewed by investors as especially risky.<br /><br />In fact Spain managed to sell €2.7bn of 10-year bonds and almost €1.3bn of 30-year bonds while at the same time bringing yields down noticeably from their earlier highs - to 4.144 percent in the case of the 10-year issue ( from 4.864 percent in June), and to 5.077 percent for the 30 year issue (from 5.908 percent in June). But, at the same time, in the background the extra yield that investors demand to hold Spanish 10-year bonds over German bunds has been steadily creeping back up again, and as of last Friday (24 September) it stood at 183 basis points, below the 220 level being asked in June but still more than double what it was at this point last year.<br /><br />Yet, despite all those nice words we hear from him, one of the things that is worrying investors right now is the real depth of Mr Zapatero’s commitment to reducing the deficit as planned, especially after he <a href="http://spaineconomy.blogspot.com/2010/08/how-many-times-can-one-driver-fall.html">unexpectedly stated on August 10 that in his opinion some of the planned infrastructure spending cuts could be reversed</a>, while on September 10 he reiterated the point, saying that lower borrowing costs may enable the government to "ease up" on some of the projected spending cuts. In fact the extra yield offered on Spanish debt has risen 33 basis points over the period since he started to mention the possibility.<br /><br />On top of which <a href="http://spaineconomy.blogspot.com/2010/09/spains-economy-enters-contraction-mode.html">all the short term indicators we have been seeing</a> suggest that the Spanish economy started to contract again in the third quarter.<br /><br /><strong>Spreads Rising Across The Periphery</strong><br /><br />Of course it isn't only Spanish bond yields which have been sneaking back up of late. Greek 10-year bonds as compared with equivalent German bunds still offer around 950 basis points (or 9.5 percent) of additional yield, only around 20 points below the all time record they hit on May 7, at the height of the Sovereign Debt Crisis<br /><br />Indeed spreads on government bonds all along Europe's periphery have been rising steadily back towards (and even in some cases beyond) their May levels in recent weeks. Most notably the last week has seen both the Irish and Portuguese government 10-year bond yields surge to euro era records levels, in a way which could lead us to ask whether, rather than Spain snuggling back into the main group the big picture story at this point might not be that it is Irish and Portuguese sovereign debt that is being prised apart from the rest.<br /><br />So rather than being over, what the debt crisis now may be entering is a new stage, where one sovereign bond after another is being chisled out and sent off to join their Greek counterpart in the isolation ward. Actually, in this sense the present European Sovereign Debt situation does rather resemble the plot of the well known Agatha Christie detective novel "<a href="http://en.wikipedia.org/wiki/And_Then_There_Were_None">And Then There Were None</a>". As told by M. Christie a group of ten people, all of whom have in one way or another been previously complicit in an earlier death, are somehow tricked into travelling together for what was intended to be a short stay on a secluded island. Once there, and even though the guests are apparently the only people on the island, they are - somehow, and one after another - systematically murdered. So, in a way which may eventually come to foreshadow scenes from the forthcoming meetings of the European Financial Stability Facility management board, each morning one guest less shows up for breakfast. One by one, and little by little, each participant becomes mysteriously overcome by a seemingly inexplicable bout of some fatal variant of what could be termed "systemic instability syndrome".<br /><br />As I say, Irish and Portuguese yield spreads are significantly wider than they were May 7, the last trading day before Greece finally agreed to go for their €110 billion bailout package and the European Central Bank announced the initiation of its ongoing program of purchasing EuroArea government bonds in the secondary markets.<br /><br />And despite holding what was considered to be a "succesful" bond auction at the start of last week Irish 10-year bond yields, shot up`once more during the remainder of the week, hitting a new record high of 6.34 per cent (see Bloomberg chart below), while yield spreads over benchmark 10 year German Bunds spiked to 416bp, euro era another record. At the same time Ireland 5 year CDS shot up to 461 bps, which meant the cost of insuring Irish debt was $461,000 for $10m of debt annually over five years.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjoES2VGE2XXucZwCY8JhQ5Qwi6Em5pWCw-w9hiDfmQp6Zf3jv1nQhA_styuQI04HZcFm_pXCF_SOyOTL8sv4_9rgYQUlBXU7HgXLtMhWt1dsbK1-d2fdzR_VhkQl19iGKuOmJ5K1EwJ09M/s1600/Ireland+10+yr+bond+yield..png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 285px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjoES2VGE2XXucZwCY8JhQ5Qwi6Em5pWCw-w9hiDfmQp6Zf3jv1nQhA_styuQI04HZcFm_pXCF_SOyOTL8sv4_9rgYQUlBXU7HgXLtMhWt1dsbK1-d2fdzR_VhkQl19iGKuOmJ5K1EwJ09M/s400/Ireland+10+yr+bond+yield..png" alt="" id="BLOGGER_PHOTO_ID_5521252317757702562" border="0" /></a><br /><br />At the same time yields on Portuguese 10-year bonds over comparable German bonds hit a record of near 4.25 percentage points Friday, while the Portuguese debt agency paid a euro era record of 6.24 percent to holders of its 10-year bonds and 4.69 per cent to holders of the four year-bonds in its own bond auction this week. In last equivalent auction, Portugal had paid 5.32 percent on 10-year bonds and 3.62 percent on four-year bonds. Portugal’s budget gap widened in the first eight months of the year, indicating the government may struggle to rein in the euro-region’s fourth-largest deficit as its borrowing costs surged to a record.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkVfQ5cRm4q8rtBjOuD3NdAOunVLuKUVjLpsT_R2Tt4b3MRIJmnMBRB2FEx80KhSFxxXVQQb39UraxDv671liKWa7uyYfecezn7pOkj-R45mYo1gOrrTaV1sGK7wZUFlYW0BhpBYIiO3Xy/s1600/Portugal+10+Year+Yields.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 285px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkVfQ5cRm4q8rtBjOuD3NdAOunVLuKUVjLpsT_R2Tt4b3MRIJmnMBRB2FEx80KhSFxxXVQQb39UraxDv671liKWa7uyYfecezn7pOkj-R45mYo1gOrrTaV1sGK7wZUFlYW0BhpBYIiO3Xy/s400/Portugal+10+Year+Yields.png" alt="" id="BLOGGER_PHOTO_ID_5521252423861155058" border="0" /></a><br /><br /><strong>Portugal and Ireland "Decoupling"?</strong><br /><br /><br />In each case the issue is different, since in the Irish case it was a sharp and unexpected contraction in the economy which became the major concern while in Portugal's case it was an apparent inability to reach the political agreement necessary to get the budget deficit under control.<br /><br />Data out during the week for second-quarter gross domestic product showed the Irish economy has never really left recession, since GDP contracted by 1.2% compared to the first three months of the year, following a downwardly revised 2.2% expansion in the first quarter. Irish GDP has now contracted on a quarterly basis for 9 out of the past 10 quarters, and there is no evident end in sight.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgMWVe_k28e7LeG38gD-RQ7WNcaRhpIGOuV6RNd4MpQYpBnL14n_gDqO2mByLGISzyvDByIwGU3VT2a9f6jxkjStmcM8bQUNn5GhDBGeUc-1GXx6AgVJU8fg_pfDneDtlOo1TSESRm29FDU/s1600/Ireland+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 208px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgMWVe_k28e7LeG38gD-RQ7WNcaRhpIGOuV6RNd4MpQYpBnL14n_gDqO2mByLGISzyvDByIwGU3VT2a9f6jxkjStmcM8bQUNn5GhDBGeUc-1GXx6AgVJU8fg_pfDneDtlOo1TSESRm29FDU/s400/Ireland+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5521257372882034962" border="0" /></a><br /><br />In addition Ireland’s central bank governor Patrick Honohan saw fit to give a rather ill-timed press conference (unless he objective really was to force the country's government into the arms of the EFSF) where he urged the government to implement even deeper fiscal cuts to restore balance to the budget in what seems at this point to be a virtually unrealisable bid to regain investor confidence. All of which left many observers wondering just what the country can do in the present situation, since the budget is evidently deteriorating due to the severity of the economic contraction, and further cuts in spending by anyone (households, companies, government) are only likely to feed the contraction even more, in their turn making even more cuts necessary. <br /><br />Obviously Ireland is rapidly approaching a situation where it cannot move the situation forward based on its own resources. This feeling is only added to by the persistent rumours that subordinated bond holders to Anglo Irish bank may well not get re-imbursed in full. These rumours have found some confirmation in a report which appeared in the Irish Examiner suggesting that the Irish Finance Minister Brian Lenihan had given a strong hint that the riskiest lenders to nationalized Anglo Irish Bank may not get all their money back. <br /><br />Mr Lenihan apparently explained to the paper that the bank guarantee program which will be extended once it runs out at the end of September may only cover deposits and not subordinated debt. <a href="http://www.ft.com/cms/s/0/7189814a-bd04-11df-954b-00144feab49a.html">And if the interpretation put on events by the FTs John Dizard's is correct</a> Mr Lenihan's delay in clarifying the situation is due to the fact that the Irish government is awaiting an EU Commission ruling on exactly this issue. His most recent official statement on the topic was that the Aglo Irish wind-up plan “is being prepared for submission to the [European] Commission for approval”. <br /><br />At the same time the EU’s Competition Commissioner, Joaquin Almunia, issued a statement that “a number of important aspects need to be clarified, and a new notification received, before the Commission is in a position to finalise its assessment and to take a decision”. Which Dizard interprets as meaning that while Anglo Irish might propose a buy-back of its subordinated bonds, and that buy-back might be included in an Irish government proposal, Brussels might, in the end, not approve the plan. Since this would effectively the first time in the current crisis that a significant group of investors did not have their losses underwritten (apart, of course, from the rather unfortunate Lehman incident), decision makers may be rather apprehensive, since no one really knows how the financial markets would react. Yet speculation some such decision will be taken remains rife, as witnessed by <a href="http://www.guardian.co.uk/business/2010/sep/27/anglo-irish-downgrade">the decision by Moody's rating agency to downgrade Allied Irish ratings</a>. Moody's cut Anglo Irish's senior bonds by three notches to Baa3, the last level before junk, but the markets' main focus was on the deep, six-notch cut in the bank's subordinated debt, to Caa1, which indicates that bondholders will be forced to pay for some of the expected bailout.<br /><br /><strong>Deficit Worries In Portugal</strong><br /><br />In the Portuguese case it is the budget deficit issue which is unsettling the markets, with the spread widening sharply following the revelation that far from the deficit being reduced is was actually increasing. According to the latest data from the Finance Ministry the central government’s shortfall during the first eight months of the year rose to 9.19 billion euros from 8.74 billion euros over the equivalent period in 2009. Previously the 2010 deficit had been almost exactly tracking the 2009 one (see chart from Societe Generale below).<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh99fdlv8XBBHssrvCYYXWnlI2dD1KpmyXF6t-BFCaRypW5W6ym5p-wXe840fBgB5smx5L9YCquvgBOYxH4_dvx1oW2iWZxmLp0eeZ_lpFTbYklPq2KZhgNTWy-4uMo_XaGyzusZyEDb0fl/s1600/Portugal+Fiscal+Deficit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 264px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh99fdlv8XBBHssrvCYYXWnlI2dD1KpmyXF6t-BFCaRypW5W6ym5p-wXe840fBgB5smx5L9YCquvgBOYxH4_dvx1oW2iWZxmLp0eeZ_lpFTbYklPq2KZhgNTWy-4uMo_XaGyzusZyEDb0fl/s400/Portugal+Fiscal+Deficit.png" alt="" id="BLOGGER_PHOTO_ID_5521252507026418018" border="0" /></a><br /><br />Portugal’s borrowing costs surged to record levels on the news, and while the spread subsequently eased back to 388 basis points, the level is still close to the zone in which Greek bonds were trading in April just before the EU offered the country emergency loans to avoid default (see Greek 10 year spread chart below).<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJ6H6tY_6VvX4hI0wejAPg7neAamoBBEVdpjrAAV9qiGJZ40gKcSPGAbIesnZzkM4rsO4hWVcG2yCBP7PO40SfMqGCDvhlUGNf9b9FWdJ0A6Sq_a8yJQ5ihUioyNJZLZDA0rt8oFfgtp9G/s1600/Greek+10+year+bond+spread.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 306px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJ6H6tY_6VvX4hI0wejAPg7neAamoBBEVdpjrAAV9qiGJZ40gKcSPGAbIesnZzkM4rsO4hWVcG2yCBP7PO40SfMqGCDvhlUGNf9b9FWdJ0A6Sq_a8yJQ5ihUioyNJZLZDA0rt8oFfgtp9G/s400/Greek+10+year+bond+spread.png" alt="" id="BLOGGER_PHOTO_ID_5521473217655445570" border="0" /></a><br /><br /><br />What this means is that this year's overall public deficit could well come in at around 9 percent of gross domestic product unless there is a radical change in policy during the last few months of the year.<br /><br />According to its commitments to the EU Stability Programme, the Portuguese government should be aiming to reduce the overall deficit to 7.3 percent of GDP in 2010 from last year’s 9.3 percent. The government has pledged to reach the target, with Finance Minister Fernando Teixeira dos Santos saying that the country “can’t afford” not to, but so far there is little evidence that it will be able to do so, and especially with all the political bickering that is now going on in the background.<br /><br />In all these cases, including the Greek and Spanish ones, this issue is not simply one of stimulus versus austerity (always a false polarity when it comes to the situation on the Euro periphery). The real issue is how to restore growth to highly-indebted and structurally-distorted economies, since without growth the debt to GDP ratios will not come down, and the burden of the debt will not be reduced. <br /><br />So more borrowing is not what these countries need right now (other than to aid short term liquidity). What the countries involved all need is more exports and larger industrial sectors, and no one seems to be very clear how they are to achieve them. Simply running a double digit deficit to generate less that 1% (in the best of cases) GDP growth is not exactly a "wise" use of resources. Evidently using deficit spending to cushion programmes which would lead to a surge in exports would make sense, but in no case is this really being done, and all the emphasis is simply going on what may turn out to be a rather fruitless and self-defeating programme of achieving fiscal rectitude.<br /><br />The result is that the peripheral countries are one by one being steadily "decoupled", with Portugal and Ireland now moving up towards Greece, as the following two charts from Citi Research clearly show.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgD73Vc9IjOPFkxRT5Rsglc-O5nS7v8upKlUzkWyArrwXqPhFPMHcjKnE6DI_-xo5oyGY7A3BQmAkaYa8zCim85rcOf-7Ueq6AlfPzGZQ_5NFO-JyyNGG6Hm8lOsj7ry4BIYu8g2njyOQAG/s1600/peripheral+spreads.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 281px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgD73Vc9IjOPFkxRT5Rsglc-O5nS7v8upKlUzkWyArrwXqPhFPMHcjKnE6DI_-xo5oyGY7A3BQmAkaYa8zCim85rcOf-7Ueq6AlfPzGZQ_5NFO-JyyNGG6Hm8lOsj7ry4BIYu8g2njyOQAG/s400/peripheral+spreads.png" alt="" id="BLOGGER_PHOTO_ID_5521252954840031442" border="0" /></a><br /><br />For quite a long time the Irish and Portuguese spreads simply moved in harmony with the Greek ones, widening as the Greek spread surged upwards. But now it is Greek debt which can be adversly affected by sentiment over the situation in Ireland or Portugal, and not the other way round, and meanwhile the other two countries slowly but surely are moving on up there to join their Greek counterparts as the second of the two charts (which show the recent relative movements in Greek and Irish spreads) seems to demonstrate.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgWnHLzkIKqXc8L-PpNIJJm1_tnJV2kb9tHNUnAEbhBfoCpjyWmxuxWufdO4U4_QyQXuPe8MM99hiTr32xz_clMtKsXBjbP_IrsAwopu6Rhvu6M3D-YsurscUqGCCYu4pFBuGYOBJ9M3TZp/s1600/Ireland+and+Greece.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 318px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgWnHLzkIKqXc8L-PpNIJJm1_tnJV2kb9tHNUnAEbhBfoCpjyWmxuxWufdO4U4_QyQXuPe8MM99hiTr32xz_clMtKsXBjbP_IrsAwopu6Rhvu6M3D-YsurscUqGCCYu4pFBuGYOBJ9M3TZp/s400/Ireland+and+Greece.png" alt="" id="BLOGGER_PHOTO_ID_5521252813332773810" border="0" /></a><br /><br /><br /><strong>Vigourous Action Needed</strong><br /><br />Naturally the ongoing deterioration in the situation requires bold and far reaching action from the Commission and the ECB. Obviously we should expect to see renewed activity on the part of the ECB, buying an increasing number of eurozone periphery government bonds. Their activity on this front has been increasing of late, but weekly bond purchases are still well below 1 billion euros a week level seen at the height of the crisis in May and June. Evidently we will see calls for more of these purchases in the days and weeks to come, but what is striking at the present time is just how ineffective they have been in containing the damage.<br /><br />The ECB’s bond buying program is effectively the second pillar in the EU crisis containment mechanism established in May. The other one is the Luxembourg-based 440 billion-euro European Financial Stability Facility, headed by former European Commission official Klaus Regling. Mr Regling has also been actively campaigning to calm markets in recent days. "It would be preferable if we didn't even have to intervene," he told the German magazine Der Spiegel in an interview, "In fact, I believe that's the most likely scenario." His hope then is that the very existence of his organization will bring calm to investors and deter speculators. "If that's the case, we'll close up shop here on June 30, 2013," he said.<br /><br /><br />Morgan Stanley’s Chief Global Economist, Joachim Fels remains pretty unconvinced by all of this. “Strains,” he wrote in a recent research report, have now reached a point where "one or several governments" may soon have to resort to the rescue mechanism. "Neither the European sovereign debt crisis nor the banking sector crisis has been resolved and both continue to mutually reinforce each other," he said, adding that the EU's stress tests for banks had manifestly failed to restore the necessary confidence. Fels's conjecture didn't need that long to get some confirmation, since <a href="http://www.businessinsider.com/the-ecb-was-this-close-to-activating-emergency-crisis-mechanism-for-ireland-last-week-2010-9">according to the German newspaper Handelsblatt</a> the ECB was last week actively considering recommending that Ireland avail itself of the fund. The Central Bank declined to comment on the story, and <a href="http://www.moneycontrol.com/news/world-news/ecb-mulled-activating-rescue-aid-for-ireland-press_487239.html">simply pointed out </a>that any decision on the matter was a question for national governments, which is formally correct (and obvious) but doesn't mean that they wouldn't in fact have recommended such a move if asked. <br /><br />So, like former US Treasury Secretary Hank Paulson before them, Europe’s leaders, having armed their bazooka may soon need to fire it. Indeed Mr Regling’s optimism that his organization may quietly disappear from the scene is not generally shared by investors, who as we are seeing seem to be continuously pricing in an ever greater likelihood of intervention.<br /><br />Meantime, <a href="http://www.ft.com/cms/s/0/ff448198-c992-11df-b3d6-00144feab49a.html">according to a report in the Financial Times over the weekend</a>, Europe's leaders are once more at odds among themselves about just how much carrot and how much stick the various national governments need to get their economies back into line. Predictably it is Paris talking about carrots, and Berlin who is talking about sticks.<br /><br />But all this talk of what to do about those countries who in the future fail to stick to the new set of rules which are apparently being prepared monumentally misses the point: what we need are some policies which help the most affected economies get out of the mess they have found themselves in following the way the monetary and fiscal policy rules were implemented last time round.<br /><br />According to one popular analogy currently circulating , the EuroArea countries could be likened to a group of 16 Alpine climbers scaling the Matterhorn who find themselves tightly roped together in appalling weather conditions. One of the climbers - Greece – has lost his footing and slipped over the edge of a dangerous precipice. As things stand, the other 15 can easily take the strain of holding him dangling there, however uncomfortable it may be for them, but they cannot quite manage to pull their colleague back up again. So, as the day advances, others, wearied by all the effort required, start themselves to slide. First it is Ireland who moves closest to the edge, getting nearer and nearer to the abysss with each passing moment. And just behind Ireland comes Portugal, while some way further back Spain lies Spain, busily consoling itself that it is in no way as badly off as the others who have already lost there footing. But if Spain cannot hold out, and all four finally go over, each dragged down by the weight of those who preceded them, then this will leave some 12 countries supporting four, something that the May bailout package only anticipated as a worst-case scenario. In the event that this is finally what happens, Mr Reglin will certainly find that the quiet life has come to an end for him, and that he has plenty of work to do, as will Mr Trichet’s successor at the ECB. In the meantime all the rest of us can do is wait and hope, firm in the knowledge that having come this far, we can only go forward, since there is no easy way back down to the point from which we started. But for heavens sake, the only thing we don't need while we sit here biting our nails is to be told by someone who manifestly has no idea what he is talking about that the danger has already past, even as we slide, inch by inch, onwards and downwards towards the chasm that gapes beneath.Unknownnoreply@blogger.comtag:blogger.com,1999:blog-8991369883287712098.post-74881568488885565392010-09-20T17:25:00.001-07:002010-09-20T19:44:45.287-07:00Sweden's general election 2010: center-right advances, yet apparently loses majorityby Manuel Alvarez-Rivera, Puerto Rico<br /><br />Despite increasing its overall share of the vote in a general election held yesterday, the four-party, center-right coalition government of Swedish Prime Minister Fredrik Reinfeldt has apparently lost the narrow parliamentary majority it held since 2006 in the Nordic country's unicameral Parliament, the Riksdag. The ruling Alliance for Sweden - comprised of Reinfeldt's Moderate Party, the Center Party, the Liberal Party and the Christian Democratic Party - scored a clear victory over the "Red-Green" alliance of the left-of-center Social Democratic Party, the ex-communist Left Party and the environmentalist Green Party, but the far-right Sweden Democrats almost doubled their share of the vote and secured parliamentary representation for the first time ever, depriving the government of an overall majority in the process.<br /><br />Nonetheless, the workings of Sweden's proportional representation electoral system - reviewed in <A HREF="http://electionresources.org/se/">Elections to the Swedish Riksdag</A> (which has preliminary 2010 election results) - also played a role in pushing the ruling parties further away from an overall majority. Specifically, in the first stage of Sweden's two-tier mechanism for distributing mandates in the 349-seat Riksdag - since 1994 elected every four years - 310 permanent seats were allocated in twenty-nine multi-member constituencies among the eight parties that polled at least four percent of the nationwide vote, with the following results:<br /><br />Social Democratic Party (S) - 113<br />Moderate Party (M) - 107<br />Green Party (MP) - 18<br />Liberal Party (FP) - 17<br />Center Party (C) - 21<br />Sweden Democrats (SD) - 14<br />Christian Democratic Party (KD) - 11<br />Left Party (V) - 9<br /><br />Now, while multi-member constituency seats are distributed by proportional representation (using the adjusted odd-number method, also known as the modified Sainte-Laguë procedure), the allocation of seats on a constituency-by-constituency basis introduces significant disparities between the distribution of votes and seats. Thus, the Social Democrats were noticeably over-represented, winning 36.5% of the constituency seats with 30.9% of the vote, while the Left Party, with 5.6% of the vote, came up distinctly under-represented with just 2.9% of the seats.<br /><br />Nevertheless, the Riksdag also has 39 adjustment seats, whose purpose is to bring about a proportional allocation of parliamentary mandates. To apportion these seats, all 349 Riksdag mandates were distributed on a nationwide basis by the adjusted odd-number method among parties polling at least four percent of the vote, with the following results:<br /><br />S - 109<br />M - 106<br />MP - 26<br />FP - 25<br />C - 23<br />SD - 20<br />KD - 20<br />V - 20<br /><br />The nationwide distribution of Riksdag seats would have left the Alliance of Sweden parties with a total of 174 mandates, or one seat short of an overall majority. However, both the Social Democrats and the Moderates won more constituency seats than the total number of mandates they were entitled to receive at the national level. Both parties kept the extra seats, but their constituency seats were subtracted from the total number of Riksdag seats, leaving 129 seats to be apportioned among the other six qualifying parties. Consequently, the allocation of Riksdag mandates changed as follows:<br /><br />S - 113<br />M - 107<br />MP - 25<br />FP - 24<br />C - 22<br />SD - 20<br />KD - 19<br />V - 19<br /><br />Because the Social Democratic Party won four mandates above the total it needed to be proportionally represented in the Riksdag, the ruling coalition's seat total was further reduced to 172 - three seats short of an absolute majority. In fact, while the Social Democrats scored a very disappointing result - the party's share of the vote fell to its lowest level since 1914 - they nonetheless had a somewhat stronger-than-expected performance and (contradicting most opinion polls) remained Sweden's largest party, albeit just barely ahead of the Moderates, who had their best result since 1914.<br /><br />Interestingly, the election outcome leaves Reinfeldt's government in a situation very similar to that faced by Sweden's previous 1991-94 center-right cabinet, headed by then-Prime Minister (and currently Foreign Minister) Carl Bildt. At the time, the four right-of-center parties held 170 seats - five short of an overall majority - and the right-wing, populist New Democracy (NyD) effectively held the balance of power with twenty-five seats; Bildt's government lasted out its entire three-year term in office with NyD's tacit backing. That said, at this juncture the Alliance for Sweden parties (or for that matter the opposition "Red-Green" parties) won't have anything to do with the anti-immigration, anti-Islam Sweden Democrats; instead, Reinfeldt's government is attempting to win over the Green Party, which polled its best Riksdag election result ever. However, the Greens don't appear to be interested so far in backing Reinfeldt, who nonetheless will remain in office unless he chooses to step down or the Riksdag brings down his government in a vote of no-confidence.<br /><br />There's also the possibility that the ruling Alliance for Sweden could secure a narrow Riksdag majority once votes cast by Swedish expatriates or electors voting outside their places of residence are tallied later this week. A comparison of election night and definitive figures for the past three general elections shows small percentage increases for the center-right parties in the final tallies, but this year's election outcome has been skewed by the four extra seats won by the Social Democratic Party at the constituency level, and a slight shift in the nationwide vote totals is less likely to change the distribution of Riksdag seats. As things stand right now, the center-right parties would win a one-seat majority if they captured three constituency seats narrowly won by the Social Democrats in Kronoberg County, in the Municipality of Göteborg and in Värmland County, respectively (over the Moderates in the first case and the Liberals in the latter two).<br /><br />At any rate, the continuing decline of the Social Democrats - who have ruled Sweden for all but thirteen of the past seventy-eight years - has led to much speculation about the end of an era of Social Democratic dominance. That could possibly be the case, and the party may eventually go the way of its Danish counterpart, which lost its political dominance at the beginning of this century and has yet to recover it. All the same, it should be remembered that following a disastrous result in 2001, the Labour Party in neighboring Norway bounced back in 2005, and has remained in power since then. From that perspective, only time will tell if the Social Democratic Party will continue to lose ground or reverse its declining electoral fortunes.Manuel Alvarez-Riverahttp://www.blogger.com/profile/08846266638893748215noreply@blogger.com