Thursday, September 18, 2014

18/9/2014: Irish GDP & GNP Q2 2014: Headline Numbers

In the previous post ( I covered sectoral decomposition of Irish GDP. Note, referenced activity in the above post and GDP are 'at factor cost', omitting taxes and subsidies.

Here, let's take a look at full valuations of real GDP and GNP, both seasonally-adjusted (allowing q/q comparatives) and seasonally un-adjusted (allowing y/y comparatives).

Starting with seasonally un-adjusted series.

Total real GDP (in constant prices) in Q2 2014 stood at EUR45.763 billion which is 7.72% above the levels recorded in Q2 2013 and marks second consecutive quarter of y/y growth (in Q1 2014 GDP expanded by 3.81%). Q2 2014 y/y growth rate in GDP is highest since Q1 2007 which is a huge print!

Profit taking by the MNCs accelerated to EUR8.016 billion in Q2 2014from EUR7.864 billion in Q2 2013 and GNP rose to EUR37.747 billion posting a y/y growth rate of 9.03% in Q2 2014, marking fourth consecutive quarter of GNP growth. The Q2 2014 y/y growth rate was the highest since Q2 2006. The level of GNP in Q2 2014 was the highest for any Q2 since Q2 2007. So we have another huge print here.

GNP/GDP gap at the end of Q2 2014 stood at 17.5%, which is worse than the gap of 16.9% in Q1 2014 but an improvement on 18.5% gap in Q2 2013. Excluding taxes and subsidies, private GNP/GDP gap reached 19.0% in Q2 2014 compared to 20.1% in Q2 2013. This means that while growth is improving domestic economic conditions, these improvements are not tracking in full overall economic activity.

In seasonally-adjusted terms, Irish economy's performance was more moderate, albeit still strong, than in y/y growth terms discussed above.

Q/Q, GDP grew by 1.54% in real terms in Q2 2014, marking a slowdown in growth from 2.79% q/q growth in Q1 2014. However, Q2 2014 marks second consecutive growth period and the first time we have posted a GDP outcome above EUR45 billion (EUR45.611 billion in fact) in any quarter since Q2 2008.

Q/Q GNP marked fourth quarter of expansion in a row with Q2 2014 uplift of 0.61% on Q1 2014, ahead of Q1 2014 growth of 0.38%. However, Q2 2014 growth was second slowest in last 4 quarters. In level terms, Q2 2014 seasonally-adjusted real GNP came in at EUR37.983 billion which is the best Q2 reading since Q2 2008. So despite growth moderation, levels performance is still relatively good.

Here are two charts plotting relative performance by quarter in terms of GDP and GNP compared to historical average growth rates for each decade.

More analysis to follow, so stay tuned.

18/9/2014: Irish GDP Q2 2014: Sectoral Decomposition

Quarterly National Accounts for Q2 2014 for Ireland have been published by the CSO and the numbers are so-far encouraging. I will be blogging on these through out the day, so stay tuned.

In this first post on QNA results for Q2 2014, let's take a look at the seasonally un-adjusted data (allowing for year-on-year comparatives) for real GDP by sector:

All sectors output rose 7.4% y/y in real terms in Q2 2014 marking second consecutive quarter of growth and significantly outperforming 3.3% growth y/y recorded in Q1 2014. Q2 all sectors output is now at EUR42.157 billion which is the highest reading for any quarter on record.

compared to Q1 2011 output now is 10.8% higher and we are running at the rate of output some 6.3% above the 2006-2007 quarterly average.

The above is undoubtedly good news.

Sectoral growth rates (y/y) breakdown as follows:

Summary of the above charts:

  • Agriculture, Forestry & Fishing sector posted a massive rose in output of 13.9% y/y in Q2 2014 coming on foot of an already significant growth of 9.3% y/y in Q1 2014. This marks fourth consecutive quarter of growth in the sector, with sector activity now up 58.1% in real terms on Q1 2011 and 28.3% ahead of 2006-2007 quarterly average.
  • Industry activity rose 6.47% y/y marking the first quarter of increases. Activity shrunk 5.09% in Q1 2014. The sector performance has pushed output 6.6% above Q1 2011 levels but is still running 5.74% below 2006-2007 quarterly average. Still, good news is that growth is back.
  • Distribution, Transport, Software & Communication sector expanded by 11.3% y.y in Q2 2014 after posting growth of 10.6% y/y in Q1 2014. This marks second consecutive quarter of growth in the sector. Sector activity is now up 3.11% on Q1 2011 and is still down 2.51% on 2006-2007 levels.
  • Public Administration and Defence sector grew 3.75% y/y in Q2 2014, marking second consecutive quarter of y/y growth in a row. In Q1 2014 the sector grew by 3.67% y/y. Despite all the austerity, sector activity is now up 1.62% on Q1 2011 but overall activity is down 8.9% on 2006-2007 quarterly average.
  • Other Services sectors posted growth of 2.7% y/y in Q2 2014 and 3.9% growth in Q1 2014. Q2 2014 marked 13th consecutive quarter of positive y/y growth in the sector. Sector activity is up 9.6% on Q1 2011 and is 8.75% ahead of 2006-2007 quarterly average.
  • Building & Construction sector posted growth of 8.99% y/y in Q2 2014 which comes after 7.63% growth in the sector in Q1 2014 and marks 7th consecutive quarter of growth. Good news, however, are moderated by the realisation that levels of activity in the sector are still running 53% below those of 2006-2007 although sector has managed to grow output by 4.4% on Q1 2011.
  • Transportable Goods Industries and Utilities sector posted y/y growth of 6.3% in Q2 2014, compensating for the decline of 5.9% registered in Q1 2014. Sector activity is now 6.7% ahead of Q1 2011 and 3.13% ahead of 2006-2007 quarterly average.
Key conclusion: strong performance in growth y/y in key sectors of the economy in Q2 2014 showing no sector contracting against 2 sectors contracting y/y in Q1 2014. As expected, Q2 output came in with stronger readings than Q1 and indications are Q3 2014 is likely to be also ahead of Q1 expansion rates.

Stay tuned for more QNA data analysis here.

18/9/2014: Quite a disappointing TLTRO round 1

So ECB's first tranche of TLTROs allotted at EUR82.6 billion - which is disappointing to say the least. Announcement is here:

Prior to the allotment, the following were forecast:

  • Credit Agricole: EUR100 billion (EUR200 billion into December tranche)
  • Goldman Sachs: EUR200-260 billion in September and December TLTROs and EUR720-910 billion in overall programme
  • Morgan Stanley: EUR250 billion in September & December TLTRO tranches and EUR100-400 billion for tranches 3-8
  • Nomura EUR115 billion in September and EUR165 billion in December
  • JPMorgan EUR150 billion in September
  • Barclays EUR114 billion in September and EUR154 billion in December.

My own view on the subject as follows (from a comment given yesterday for international publication).

Note that the take up today has been disappointing for all above expectations (my own included), suggesting that traditional LTROs roll-overs dominated decision on TLTRO demand. This means that going into AQR reviews by the ECB the banks are reluctant to expand their corporate lending balance sheets and the loading now is on much heavier take up of TLTROs in December. In the mean time, low take up in this tranche can put some added pressure on ECB to deploy its ABS purchasing programme.


The key difference between TLTROs and LTROs is in the targeted nature of TLTROs. Conventional LTROs (despite the fact that term 'conventional' can hardly apply to these rather exceptional instruments) are unrelated to the balancesheet exposures of the banks and are designed to simply inject medium-term and long-term liquidity into the banking system as a whole. Thus, in the environment of deleveraging and uncertainty with respect to future losses, LTRO-raised funds flow to government securities with lower / zero risk-weighting and high liquidity. The effect is to reduce yields on Government securities, without providing any meaningful uplift in lending to the real economy. De facto, LTROs helped alleviate the sovereign debt crisis on 2010-2011, but also resulted in increased credit markets fragmentation and did nothing to reduce credit supply pressures in the real economies of the euro area countries. TLTROs - via targeting levels of real credit exposures to non-financial corporations - are holding a promise to shift funds into credit markets for companies, with weighting formula favouring banks with greater exposures to such lending. If successful, TLTRO programmes can incentivise banks to lend on the basis of risk-return valuations, which can, in theory, also alleviate the problem of financial markets fragmentation by attracting euro area banks into lending in the so-called 'peripheral' economies.

At this stage, both demand and supply of credit in the majority of the euro area economies are well outside the fundamentals-determined levels. The financial markets are severely fragmented and the ongoing deleveraging of the banks and companies balancesheets still working through the credit markets. This means that any forecast for TLTROs uptake and effectiveness are subject to huge uncertainty. My view is that we are likely to see rather cautious take up of the TLTRO funds in the first round, with many lenders dipping into the funding stream without full commitment. We are looking at the take up of around EUR100-150 billion in Thursday TLTROs. One reason for this is that the first tranche of TLTROs is likely to go into replacing maturing 3-year LTRO funds rather than new expansion of the banks balancesheets. To-date, banks repaid some EUR649 billion of LTROs, with EUR370 billion outstanding. Close-to-redemption LTRO funds need replacement and TLTROs are offering such an opportunity, albeit at a cost (TLTROs are priced 10bp higher than LTROs but offer longer maturity). All-in, the banks are likely to go for roughly EUR300 billion of TLTROs (with total potential allotment of EUR400 billion available, the cost will be the main factor here), with under half of this coming in September and the balance in December. Another reason pushing TLTROs demand into December, rather than September, is the ongoing ECB review of the banks (AQR analysis).


ABS measures are going to aim to address the size of the ECB balancesheet, while providing support for effective yield on loans to the real economy. In this, well-structured ABS purchasing programme can provide support for TLTROs by increasing incentives for the banks to lend funds to corporates. However, excessive focus in the ABS programme on quality of assets and risk pricing can posit a risk of increasing fragmentation in the markets, as such focus can drive a significant wedge in pricing between corporate yields in the core economies of the euro area and the 'periphery'.

I do not see the ECB deploying traditional QE programme at this point in time. The reason for this is simple: yields convergence in the Sovereign markets is ongoing, levels of yields are benign, and demand for sovereign assets remains strong. However, if TLTROs and ABS programmes prove to be successful, we may see banks exits from low-yielding sovereign debt (core euro area) and from high yield, but now significantly repriced peripheral debt (profit taking). Unlikely as this might be at this point in time, if such exits prove to be aggressive, the ECB will have to provide support for sovereign yields and a small-scale QE can be contemplated in this case.

In general, however, it is clear from Mr Draghi's recent speeches and statements that he sees two key problems plaguing the euro area economies: the problem of high structural and cyclical unemployment and the problem of low private investment. Both of these problems continue to persist even as the sovereign debt yields have fallen dramatically, suggesting that government spending stimulus and investment programmes are unlikely to repair what is structurally a longer-term set of weaknesses in the economy.

Wednesday, September 17, 2014

17/9/2014: Belarus v Ukraine: Income per Capita

Someone just asked me a question as to what is the relative income in Belarus vs Ukraine. Here is the data on GDP per capita basis (PPP-adjusted to reflect exchange rates and price levels differences) for main CIS countries (click to enlarge):

Note: as Ukraine is now a programme country for the IMF, forecasts end at 2014.

Sorted. Enjoy.

On related note, here are some other comparatives including Belarus and Ukraine: see table at the bottom of the post.

17/9/2014: Letting Go Ireland's Tax Arbitrage Model Will be a Painful Process

OECD has put forward their proposals for new international tax rules that, in theory, could eliminate tax-optimisation structures that have allowed many multinational companies (such as Google, Apple, Pfizer, Amazon, Yahoo and numerous others) to cut billions of dollars off their tax bills. The proposals were prompted by the G20 request issued last year and the measures announced this week have already been agreed with the OECD’s Committee on Fiscal Affairs (44 countries).

The proposals form just a part of the overall international tax reforms package called “Action Plan on Base Erosion and Profit Shifting” that will be unveiled in 2015 and is commonly known as BEPS.

There are two pillars in the current announcement.

The first pillar addresses only some of the abuses of dual-taxation treaties that generally aim to prevent double taxation of companies trading across the borders. The OECD is proposing to make amendments to its model treaty package that would prevent cross-border transactions from availing of tax treaty reliefs whenever the principal reason for the transaction is to avoid tax liability. This is a principles-based change, recognising the spirit or the principle of the dual-taxation treaties. De facto, the aim is to prevent the situation where preventing dual taxation leads to the scenario of dual non-taxation.

As with all principles-based reforms, the devil will be in the fine print of the actual regulations and economist's mind is not the best guide for sorting through these. From the top, were the measures to succeed, profits shifting via the likes of Ireland to tax havens will be if not fully stopped, at least significantly impaired. The result will be putting at risk tens of billions of economic activity booked via Ireland. In some cases, practically, this will mean that activity will be re-domiciled to other jurisdictions, where it really does take place. In other, however, it will become subject to tax in the country that stands just ahead of the tax haven in the pecking order of revenues flows. Ireland might actually benefit here, since our tax regime is still more benign than that offered in other countries.

To support the first pillar, however, the OECD also wants to restrict the amount of profits that a company can report in its intra-company accounts when these are based offshore. In effect this will put a cap on how much of their activity companies can attribute to the intra-company transactions or to force companies to redistribute profits generated by intra-company divisions across the entire group.

This is likely to undermine our ability to gain from re-allocation of revenues mentioned above. For example, suppose a company has a division based in Ireland that holds the company IP. The division is highly profitable, despite being very small: revenues it earns from other parts of the company operating around the world are covering the alleged cost of IP. If these profits were capped and/or required to be redistributed around the world to other divisions of the same company, the incentive for the company to retain its IP in tax optimising location, such as Ireland, will be gone no matter what our tax rate is.

The second pillar relates to the rules on tax residency. In particular, the OECD said that the existent rules that allow companies to operate facilities in a country without registering tax residency there should be abolished. The result, if adopted, will be to force companies like Google, Apple and Amazon to pay taxes on activities carried out in larger European states in these states by removing the channel for profit shifting to Ireland and other countries. The OECD is explicit about this by insisting that companies with 'significant digital presence' in the market should be forced to declare tax residence in that country.

Ireland's official response to this threat is that majority of MNCs trading from here do have significant presence here in form of large offices and big employment numbers. This is a weak argument for two reasons. One: Irish operations are relatively small for the majority of MNCs, compared to their global workforce. Two: majority of Irish operations of MNCs are sales, sales-support, marketing and back office. In other words, these support larger markets workforce.

The first pillar of the proposal is likely to impact sectors such as phrama and tech, where significant profits are generated by IP, trademarks and patents and these are often held off-shore in what are de facto shell subsidiaries not registered for tax purposes in the countries where actual activities of the company are based.

The second pillar is even more damaging to smaller open economies such as Ireland, because it mirrors the old EU proposal for CCCTB basis of corporate taxation. This pillar will likely push activities that are registered in countries like Ireland back into the countries where actual transactions take place, favouring larger economies over smaller ones.

For example, take a US company running sales support centre in Ireland servicing Spain. This activity is supplied by Spanish-speaking, largely non-Irish staff that has been imported into Ireland not because they are more productive here or have better human capital or face lower costs of employing, but because their presence in Ireland allows the company to book sales in Spain into Ireland. In fact, absent tax arbitrage, it would probably be cheaper for the company to employ these workers in Spain.

Back in 2013, Reuters reported that 3/4 of the largest US MNCs in tech sector channeled their revenues from sales across the EU into Ireland and Switzerland, avoiding reporting these activities in the countries where actual customers resided.

If OECD proposals are implemented to reflect the spirit of the reforms, the tax arbitrage bit of the abnormal return on locating labour-intensive activities in Ireland will be gone. This, by itself, may or may not be enough to put those jobs on the airplanes back to Spain, Italy, Germany, France and elsewhere. But if other countries start making themselves more competitive in labour costs, tax and regulatory regimes, defending Ireland's competitive proposition will be harder and harder.

This process - of erosion of Irish competitive advantage - will be further accelerated by the OECD proposals on tax data sharing and clearance which envisages massive increase in the data reporting burdens on the multinational companies. The cost of compliance and audits this entails will be large and increasing in complexity of companies' structures, leading to more incentives for them to rationalise and streamline their operations worldwide. A tiny market, like Ireland, much more efficiently serviceable via the larger economy like the UK, is unlikely to win in this race.

OECD proposals can have a pronounced effect on economic growth, employment and financial health of a number of countries, including Ireland, Luxembourg, Switzerland, and the Netherlands because the proposals will force MNCs to change their global operations structures and move jobs out of tax optimisation states toward the states where real activity takes place.

From Ireland's point of view, closing off of the loopholes can have a dramatic effect on the ground if it is accompanied by other trends, such as renewed corporate tax rate competition that can challenge our attractive headline rate of 12.5%, erosion of Irish regulatory and supervisory regimes competitiveness, increase in cost inflation and other inefficiencies. Instead of competing on being a tax arbitrage conduit, Ireland will have to start competing on the basis of real economic fundamentals, such as skills, public policy, public goods and services, private markets efficiencies, etc.

Ironically, the threat of the elimination of tax arbitrage opportunities can result in Ireland becoming more competitive and more successful over time, assuming the Governments - current and subsequent - play it smart.

Tuesday, September 16, 2014

16/9/2014: Mapping Uncertainty Across Industries

A very interesting post on HBR Blog ( mapping technological uncertainty against demand uncertainty across major industries.

Two charts:

16/9/2014: Allegedly, Irish Consumers Have Pulled Back Spending in August

It is with some puzzlement that I read the following tweet:

Being aware that there has not been any new data on retail sales or consumer demand issued today, I opened the link:

It turns out that the 'pulling back' of 'spending' is really a 'pulling back' of consumer confidence.

And indeed, as chart below shows, Consumer Confidence reported by the ESRI fell from a very high reading of 89.4 in July to 87.1 in August:

Now, we do not have August data for retail sales yet. And these may or may not have fallen. But Consumer Confidence decline has preciously little to say about the actual household spending or consumer demand or retail sales. Especially in the medium (3 months and over).

Take a look at data we do have:

  • In January 2014, Consumer Confidence rose m/m strongly, but seasonally-adjusted retail sales barely rose in value terms and strongly shrunk in volume terms.
  • In February 2014, Consumer Confidence rose again strongly, but seasonally-adjusted retail sales remained unchanged in volume terms and fell strongly in value terms.
  • In March 2014, Consumer Confidence moderated significantly, and retail sales fell in volume and value terms.
  • In April 2014, Confidence rose dramatically and both volume and value indices of retail sales rose as well. 
  • In May 2014, Confidence indicator tracked both retails sales indices to the downside.
  • In June 2014, Confidence tracked volume and value of retail sales to the upside.
  • In July 2014, Confidence rose dramatically, but retail sales shrunk in both volume and value terms.
So in last 7 months, Consumer Confidence changes tracked changes in actual consumer demand in 4 and did not track demand in 3. That is hardly a record to base any conclusions on. But historically things are even worse.

The chart above shows that Consumer Confidence historically shows a weak relationship with the Volume of Retail Sales and a very weak relationship with the Value of Retail Sales. Worse, these weak relationships fall to nil - or vanish completely - for quarterly readings:

So whatever KBC lads might say, ESRI Consumer Confidence does not indicate that households pulled back their spending in August. It might, however, suggest that consumer are not expressing same levels of enthusiasm about their current prospects and this might mean they could have pulled back spending. 

16/9/2014: Ukraine Passes Far-Reaching Law on Eastern Regions Decentralisation

After ten days of ceasefire, the Ukrainian Parliament (Rada) ratified a very significant new bill, introduced by President Poroshenko, that

  • guarantees a "special status" based on a degree of self-rule for the self-proclaimed separatist territories, the Donetsk and Luhansk "People's Republics", for a period of 3 years
  • allows for policing by local militias in specially designated areas of self-rule
  • provides protection (yet to be defined) for Russian language
  • permits local governments' autonomy in establishing and strengthening of "good neighbourly relations" with Russia
  • promises Kiev funding to rebuild the regions (not specified amount and/or conditions)
  • sets the date for local elections: December 7

A separate bill guarantees amnesty for "participants of events in the Donets and Lugansk regions", which implies three things of note:

  1. the bill does not reference separatists as terrorist - a major departure from past practices; and
  2. grants symmetric amnesty to both sides, including the volunteers fighting on the side of the Ukrainian forces; and
  3. provides no exceptions on the basis of citizenship - so all foreign fighters on both sides are, presumably, included in the amnesty.

It is worth noting that the amnesty does not cover those responsible for the shooting down of the MH17 as well as rebels accused of other "grave" crimes (per BBC report).

In my view - this is a major and very positive departure from the past policies for President Poroshenko which is made even more significant by the fact that Ukraine is going into acrimonious and challenging political campaign for the new parliamentary elections. It took some guts and political will for President Poroshenko to push this through. For example, Yulia Tymoshenko, the former prime minister and presidential candidate, labelled the bill a "complete surrender". As quoted in the Telegraph, she stated that "This decision legalises terrorism and the occupation of Ukraine".

It must be reiterated again, President Poroshenko deserves huge credit for taking this major reconciliatory step and the bill, in my opinion, provides a very good roadmap for securing longer-term dialogue between all parties on how to rebuild the region within the united Ukraine. It is my sincere hope that the separatists will fall fully behind this process.

Signals from the separatists are, however, quite mixed. Igor Plotnitsky who heads Luhansk separatists, as reported in the Telegraph, said the bill met several of his demands and that "a peaceful resolution has been given its first chance". In contrast, Andrei Purgin, the so-called deputy prime minister of the Donetsk People's Republic, said that the bill only offers a possible starting point for discussions. This is unfortunate.


16/9/2014: If China Growth Fall-off is Structural... Who's Going to Drive Global Growth?..

BOFIT published their revised forecasts for Chinese economic growth 2014-2016 and the numbers are just not pretty... not quite ugly, but not pretty. 2014-2015 forecast is for 7% growth - which is a 'psychological' bond for growth in China as it entails a 10-year doubling horizon and is alleged to be supportive of demographic changes. 2016 growth forecast is for 6% - or sub-7% magic number.
All in, 2014-2016 are expected to show slowest growth since the start of the millenium and these come on foot of two previous years of growth below 8%. So far, H1 2014 posted growth of 7.5%, down from 7.7% growth in 2013.

Interestingly, BOFIT note: "If the indicative data showing a relatively good employment picture are credible, even growth lower than forecast here may be suffi-cient to satisfy the needs of the Chinese society. China’s traditional official growth targets, crystallised in a single number, have outlived their purpose. They fail to guide market ex-pectations and policies in a way that reflect economic fundamentals."

The drivers of Chinese economy slowdown appear to be very similar to those impacting Russian economy: exhaustion of the investment boom. "The current slowdown in growth is quite natural given the size of China’s economy, its resource demands and increased level of development, but there are also other factors con-tributing to the slowdown. In the wake of a decade-long investment boom, new investment no longer delivers the same “bang for the buck” it did earlier. A corollary to China’s aging population is the decline in the number of work-age people. Vast environmental degradation comes with hefty costs that are already eroding growth. Finally, short-term growth will be subdued by high indebtedness that limits the government’s room to manoeuvre in the fiscal and monetary policy spheres."

The Big Hope has always been that falling investment will be offset by rising consumption. Which is what provides upside support to BOFIT forecasts. But one must ask a simple question: if debt is already a problem, who will be paying for this increasing consumption?

In case you wondered, that 'soft landing' meme is still around, but it is now being increasingly questioned: "A controlled “soft landing” for economic growth is by no means a given at this point. Remaining on the appropriate glide path will require strong economic and reform policies. The rising indebtedness of firms and local governments remains a top challenge for China’s multi-tiered economic policy matrix. Worryingly, the credit boom in China this decade tracks several earlier credit booms in other countries that ended in crisis. Darkening the mood further is an impending correction in the real estate sector. While Chinese financial markets have been relatively calm in recent months compared to a year ago, the shadow-banking sector continues to grace the headlines with stories of defaults and other problems. "

Key point is that China is not expected to support significant upside to global growth through 2016. And this leaves global growth dependent on G7...

Full forecast is available here:

16/9/2014: More of a Risk, Less of a Bubble: Irish Property Prices in Q1 2014

An interesting BIS paper on House Prices data across a number of advanced economies ( A key chart:

Data is through Q1 2014 and is based on the aggregate of 8 data sets for Ireland. It is worth noting that data is for Ireland overall, not Dublin.

In the nutshell, in Q1 2014 Irish property prices were still at the lower end in terms of price/rent ratio and price/income ratio.

An interesting contrast to other peripheral and advanced economies in terms of dynamics:
"Year-on-year residential property prices, deflated by CPI, rose by 9.5% in the United States and 6% in the United Kingdom. Real house prices also grew, by 7% in Canada, 7.7% in Australia and 2.2% in Switzerland, three countries that were less affected by the crisis, as well as in some countries that were severely affected by the crisis, such as Ireland (+7.2%) and Iceland (+6.4%).  Real price growth remained in negative territory in Japan (–2.6%) and was generally weak or negative in continental Europe. Prices rose in Germany (+1.2%) and the Nordic countries (+1.7% in Denmark and +4.8% in Sweden), but continued to fall in the euro area’s southern periphery (Italy, –5%; Spain, –3.8%; Portugal, –1.2%; and Greece, –6%). "

So as I noted before, two points of concern and two points of solace:

  • Dynamics of prices, not levels, are signalling serious problems in the markets;
  • Dublin is the core driving factor for this with the rest of the country barely showing much of an improvement;
  • Levels of prices remain benign in relation to incomes and to rents, especially outside of Dublin;
  • Compared to other peripherals, we are witnessing much faster recovery supported by significant past falls in prices relative to income (note similar levels of prices in Iceland, although prices recovery and dynamics are more concerning there than in Ireland).

16/9/2014: World's top 35 Military Powers

Quite superficial, but nonetheless a ranking of military systems around the world:

Source: Centre for Arms Control and Non-Proliferation

Monday, September 15, 2014

15/9/2014: OECD Economic Outlook: It's Worse than the Cover Says...

Keeping in mind that the OECD is a cooperative international body (aka not known for taking strong positions on anything, save lunch menu), here's Paris-based boffins' latest outlook for the global economy in 2014:

Everyone is downgraded, save India. Poor Italy got blasted - forecast for 2014 growth is now 0.9 percentage points lower than back in May and the 'powerhouse' of the euro area, Germany, is expected to grow by just 1.5% this year despite booming current account.

2015 is not going to be much better either:
OECD expects euro area to grow at 1.1% in 2015, which is slower than its forecast for the common currency area for 2014 produced back in May 2014. In other words, the expected 'new' recovery is worse than expected 'old' current outlook.

And world trade slowdown is now pretty much structural:
Domestic demand is likely to stagnate just as external demand, especially in the euro area as jobs creation remains anaemic and wages growth is nowhere to be seen, even at low inflation rates:

What the OECD has to say on the euro area reads like a description of a full-blow Japanization:
"The recovery in the euro area has remained disappointing, notably in the largest countries:  Germany, France and Italy. Confidence is again weakening, and the anaemic state of demand is reflected in the decline in inflation, which is near zero in the zone as a whole and negative in several countries. While the resumption in growth in some periphery economies is encouraging, a number of these countries still face significant structural and fiscal challenges, together with a legacy of high debt. "

Meanwhile, door knobs of European policymaking are calling for raising domestic demand to combat debt overhang. Now, definition of Domestic Demand is: Personal Consumption of Goods & Services + Net Expenditure by Local & Central Government on Current Goods & Services + Gross Domestic Fixed Capital Formation = Final Demand. Add to Final Demand Value of Physical Changes in Stocks and you have Total Domestic Demand.

Take a look at the above components:

  • Personal Consumption of Goods & Services is subject to significant downward pressures due to tax increases, cost of government-supplied / controlled goods & services increases and household debt overhang. To increase this without increasing debt overhang for households requires shifting some of the Government burden off shoulders of the households. Which will only add to Government debt pile.
  • Net Expenditure by Local & Central Government on Current Goods & Services is held back by Government debt overhang and large deficits. To stimulate this will require heavier debt overhang or more taxation of households, which will only increase their debt overhang and depress their demand. 
  • Gross Domestic Fixed Capital Formation is held back by corporate debt overhang and broken credit system (down to banks debt overhang). Stimulating investment - aka fixed capital formation - will either require companies to increase their debt overhang (more credit issuance) or increase Government spending (see above) or dilute equity in companies.
In short, there is not such thing as a debt-neutral 'stimulus' when debt overhang is present across all sectors of the economy, as in euro area periphery, and in a number of other euro area states.

Boffins from the OECD have this to say on euro area's alleged malaise Numero Uno: low inflation. "Inflation has been falling steadily in the euro area for nearly three years. As demand strengthens, inflation is expected to turn back up and gradually converge on the EBC’s target range. But the succession of downward surprises has increased the risk that inflation remains far below the ECB’s target for a more extended period or declines further. Excessively low inflation makes it more difficult to achieve the relative price adjustments that remain necessary to rebalance euro area demand without having to endure a prolonged period of slow growth and high unemployment. Inflation near zero also clearly raises the risk of slipping into deflation, which could perpetuate stagnation and aggravate debt burdens."

In my view, this is just plain bollocks, pardon my language. Why? 

Because low inflation only exacerbates debt burden in ratios to GDP, not in real terms and even then  only for the Governments. Low inflation means low interest rates, which reduce cost of debt servicing for all actors in the economy: households, governments and corporates. Higher inflation equals higher interest rates, which means that you are killing households and companies in order to drive that debt/GDP ratio down for the Government. Meanwhile, economy's cost of servicing the debt levels, not ratios, is rising. This is why deflation with low growth are unpleasant but bearable in debt overhang scenarios (see Japan) while stagflation (low growth and high inflation) is a disaster. 

Need more convincing? Suppose inflation reaches ECB target of 2%. Suppose we post real growth of 3% pa. Which makes our nominal growth in the economy around 5% (simplifying things, but only marginally). What happens to interest rates? Why, they go toward historical averages. Say benign 2.5%. What happens to legacy mortgages rates? They more than double for trackers and rise by at least 2.5 percentage points for ARMs. What happens to mortgages arrears? What happens to household consumption? What happens to household investment? If growth of 5% is driven, as currently, predominantly by external sectors (exports and foreign investment, including in property markets), what happens to earnings and wages that are supposed to pay for the household debts and purchase domestic companies' goods and services? And what happens to Government yields and with them debt-servicing costs?.. 

OECD rather cheerfully presents the following outlook for inflation:
Which suggests we are heading for mean reversion (increases) in interest rates on 5-10 year horizon. Fingers crossed by then foreign investors will be snapping homes in Ireland at prices close to 2005-2006 peak so we can at least foreclose on them without much of negative equity overhang...