By Claus Vistesen, on October 16th, 2009
Who does not like a good argument? I for one do, especially when it comes to economics. A lot of water has already gone under the bridge relative to the note published a couple of weeks back by VariantPerception on the Spanish banking sector which provided a timely and, in my opinion, accurate analysis of the issues facing the Spanish banking and financial system as a function of the dire macroeconomic situation Spain finds itself with skyrocketing unemployment and lingering (and entrenching) deflation. Now, the reason that I point out how “a lot of water has gone under the bridge” is quite simply that I know the people at Variant and, as you know, I also know Edward Hugh who was very effective in dessimating the conclusions of the report across his (second) empire now growing on Facebook. As Edward noted here on A Fistful of Euros in the immediate aftermath of VariantPerception’s report, it quickly got a lot of attention.
Now, I wish that I could present PDFs of both reports here (i.e. the VP and Iberian Equity report), but I can’t due to the fact that such reports are usually behind the firewall. However, this first note by FT’s Alphaville on the VP report and the second note, just published, on the challenge by Iberian Equities are enough to get a sense of the argument.
I have seen VP’s rebuttal and I still square with their side of the fence. Especially, Iberia Equities make the following point in their report;
“Variant claims Spanish banks are not marking their loan books to market. Non-performing loans in Spain (4.6% of the system’s loans by the end of Jun’09) are marked-down according to different provisioning calendars set by the Central Bank. For non-mortgage loans, NPLs are provisioned at the end of year 2. The majority of mortgage loans (40% of loans or two thirds of mortgage loans) have been – until the BoS made changed the interpretation of the rule – also 100% provisioned by year 2. Only a small fraction of
low –risk mortgages (20% of loans) are provisioned according to a long calendar (100% provision by year 6). By international standards, Spain’s provisioning calendars are quite strict especially considering >60% of loans have a mortgage collateral”.
To which VP replies;
“Non-performing loans are being passed off as current, vacuumed up and rolled ito cedulas to deposit at the ECB’s repo window. (Incidentally, that is the only way many Spanish banks are finding any semblance of liquidity right now. Without the ECB, some Spanish banks would have the same liquidity problems that subprime mortgage originators had. The ECB is a mega warehouse, effectively, for the Spanish banking system. This is intimately tied in to the question of funding excess consumption in Spain, which we discussed.)”
In my opinion and apart from the glaring neglect, in the Iberian Equity report, on the macroeconomics of the situation this is the most important omission. This is to say, that had it not been possible (which it still is) for Spanish banks to park many of their assets at the ECB as collateral for funding, they would have effectively needed to mark to a non-existing market (i.e. write off the whole thing in one swoop in which case it would have been bye bye Sandy). I mean, this was what happended with Bear Stearns and Lehmann and then only afterwards did the Fed (and the “appointed” buyers) wade in to scoop up these assets which are now sitting and waiting for better times (presumably, I mean, I don’t know how quick they are ground down to reflect market fundamentals).
So, as you can see, I am still with VP here but not everyone may agree in which case it is naturally something which should be debated with facts and reason.
By D H Smith, on October 16th, 2009
“There has to be a counterweight to the malevolence of the insurance industry.” So says Senator Jay Rockefeller said to mop-topped interviewer Al Hunt of Bloomberg.
Malevolence? What’s next out of the mouth of the Democratic senator from the state of Tourette’s syndrome?
You will wait in vain for the industry to fight back hard against this Alinskyite campaign of vilification. Like all other industries that depend upon the US government to treat them with minimal sanity, the insurance industry deals with Uncle Sam the way you would any other lunatic with a trunkful of loaded guns . . . veeeeeeeeeery caaaaaaarefully, for fear of pissing off the lunatic and having him go berserk.
This is the state of play for all owners of capital in the United States today. They hold their breaths; they hold their tongues; they even contribute to the lunatics’ campaign, hoping it will buy them some goodwill! Look how well that has worked for you, health insurers — you’re public enemy number one.
The last trade association leaders who was any damned use at all to his membership was the late Jack Valenti of the Motion Picture Association of America.
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By D H Smith, on October 16th, 2009
from Marketwatch: General Electric profit slumps 44%
Financial business being run down rapidly, industrial business, a basic GDP play, seeing 8% lower revenues from the year ago period.
The pre-eminent American industrial company manages decline.
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By Claus Vistesen, on October 15th, 2009
This one should really go on Beta.Sources, but I thought that it deserved attention over and above the fold too. It is a couple of years old, but still well worth a look; hat tip (an old BW blog post).
We investigate the consequences of demographic change for business cycle analysis. We find that changes in the age composition of the labor force account for a significant fraction of the variation in business cycle volatility observed in the U.S. and other G7 economies. During the postwar period, these countries experienced dramatic demographic change, although details regarding extent and timing differ from place to place. Using panel-data methods, we exploit this variation to show that the age composition of the workforce has a large and statistically significant effect on cyclical volatility. We conclude by relating these findings to the recent decline in U.S. business cycle volatility. Using both simple accounting exercises and a quantitative general equilibrium model, we find that demographic change accounts for a significant part of this moderation.
Over and beyond the idea that demographics may act as a strong catalyst of capital flows (i.e. domestic savings/investment dynamics) and thus how demographics may transmit volatility in the global economy, the direct relation between volatility and demographics is fascinating. In fact, it is of course entirely intuitive if you apply e.g. a life course perspective in which you look at issues such as timing of housing purchase, durable and non-durable purchase, as well as the ultimate transmitter; age dependent risk aversion and/or an age dependent intertemporal consumption decision profile.
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By Eldon Mast, on October 15th, 2009
As a Q3 positive earnings season rolls on, JPMorgan Chase and Intel ignited the markets on Wednesday. Later in the day, minutes from the Fed’s most recent meeting reaffirmed our convictions that this recovery indeed will be strong and prolonged.
Intel reported third quarter revenue of $9.4 Billion which represents the largest second to third quarter growth in over 30 years. You will remember that earlier in the year Intel was one of the first firms to invest significantly during the downturn, continue to forecast recovery in 2009, and further downplay any notions that a recovery would be lackluster and bumpy. So far, their forecasts have be right on target.
JPMorgan, the first of the big banks to release earnings for Q3, reported a $3.59 billion profit. In a significant trend reversal, the company said for the second straight quarter there are actually now signs of stabilization in delinquencies among its consumer loans.
And as the markets continued their steep drive higher, the minutes of the two-day Federal Reserve FOMC meeting that concluded Sept. 23 were released. They contained the most explicit statement yet from the Committee that it now firmly believes the recession that started in December 2007 is over.
According to the minutes: “Many participants noted that since August, they had revised up their projections for the second half of 2009 and for subsequent years.”
Like Q2, Q3 results continue to surprise, surprise, surprise.
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By Rok Spruk, on October 14th, 2009
The World Bank has recently released the latest Doing Business 2010 report, measuring the level of business and economic regulation around the world. In spite of the financial crisis and the global recession, Singapore, New Zealand, Hong Kong and the United States retained the leadership as the most friendly locations for doing business. Notably, some countries have achieved high ranks. For example, Saudi Arabia moved to 13th placed and Georgia, once the bastion of Soviet-style state capitalism, now ranks as 11th most friendly place for doing business with open investment environment and low regulatory barriers to trade, entrepreneurship and investment. Countries such as Georgia, Thailand and Saudi Arabia have surpassed countries such as Sweden, Finland and Iceland although there is a notable difference in international comparison of those countries when it comes to the issues of the rule of law, property rights and institutionaly quality.
Douglass North, the 1993 Nobel-winning economist once famously wrote the essence of institutional quality for economic development. He said that the inability of societies to develop effective low-cost institutions is the major reason of today’s contemporary underdevelopment of the third world. In terms of the ease of contract enforcement, 3 out of top 10 countries are Iceland, Finland and Norway where institutional quality and the rule of law are on the high level by all international indices and comparison.
In recent decade, embracing free-market ideas has had a significantly positive impact on the institutional quality, regulatory barriers and the overall quality of business environment – all of which affect the size of transaction cost and, by empirical evidence, the standard of living and the wealth of nations. Global economic integration further induced institutional competition in terms of tax structure, regulatory environment, administrative barriers and labor market structures. Thus, when countries such as Georgia, FYR Macedonia, Moldova, Liberia and United Arab Emirates, enacted the liberalization of the business environment, the results were significant ever after. The World Bank also published the list of top 10 reforms in 2010 among which are Rwanda, Kyrgyz Republic, FYR Macedonia, Egypt, Moldova, Belarus, Columbia, United Arab Emirates, Tajikistan and Liberia (link).
The efforts to deregulate and liberalize business environment worldwide, will have a strong impact on high-income countries to remove the existing barriers to trade and investment such as high tax burden, rigid labor market structure and government size relative to private sector. 2008/2009 financial crisis and the growing role of government in the economy will probably deteriorate the country ranking in the next year. However, the leadership in the quality of business and regulatory environment will depend on further liberalization of the business environment, particulary the labor market, which is a major backbone of high-income countries where union density and regulated labor markets are widespread.
If countries such as Italy, France, Germany and the rest of the developed world will hesitate in reforming the remaining barriers to trade, more direct investment flows will move to high-growing emerging markets where macroeconomic stabilization is proceeding and where policymakers impose reforms faster then their peers in the developed world.
If such trend continues, emerging markets will soon reap the benefits and could become the leaders in reforming the business environment, attracting direct investment and, by and large, in economic growth and catch-up with the rest of the world.
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By Ajay Shah, on October 14th, 2009
- David Oakley reports on Brazil having made it to investment grade. This is their payoff to the immense progress that took place in the last decade in terms of fiscal, financial and monetary institution building. In many respects, India’s starting conditions today are similar to where Brazil was before these reforms.
- Robert Shiller, in Financial Times defends financial innovation, and Robert Cryan, in New York Times worries that Canadian banks missed opportunities in this crisis.
- Chiraga Chakrabarty, in DNA, on the need for INR/EUR futures. Once INR/USD and INR/EUR futures are trading, futures on USD/EUR will close the currency triplet and ensure efficient pricing of all three.
- Raghuram Rajan in Financial Times on the neat idea of requiring banks to hold debt capital that will convert into equity when two triggers are met.
- Read about Larry Summers and the US economic policy process in New Yorker magazine.
- Anil Padmanabhan has an important column in Mint on the mess that is shaping up on the Goods and Services Tax.
- James Lamont describes the world’s third largest producer of Gherkins: a firm named Global Green, out of Bangalore.
- On TV, Vivek Law takes on the mess found in fund management products sold by Indian insurance companies.
- Nell Minow in Financial Times with new thinking about corporate governance.
- Ila Patnaik on RBI’s next moves. Also see The good news, analysed better and This is no time for a rate hike.
- Vimal B in Financial Express on the internationalisation of the Chinese yuan.
- Jayanth Varma is scathing about the SEC’s efforts at being motherly towards fat fingers.
- India’s New Capital Restrictions: What Are They, Why Were They Created, and Have They Been Effective? by Bryan J. Balin of The Johns Hopkins University School of Advanced International Studies (SAIS).
- Alan Blinder thinks that we should all be long India.
- Shubhashis Gangopadhyay pleads for the removal of capital controls against venture capital and private equity.
- Counterfactual history, by Ramachandra Guha: Episode 1: What if Subhas Chandra Bose had returned home sometime after WW-II ended?.
- How Sam Yin Chueh changed the world.
- We have serious problems with freedom of press in India.
 
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By Claus Vistesen, on October 14th, 2009
What follows is the reason that last week was completely quiet here at Alpha.Sources. Essentially, I was working away on a detailed look at the ECB’s balance and the related question of whether we can call, what it is that ECB the is doing quantiative easing or not? Needless to say, I think that this question is an important one in a general context since if I am right and if the crisis has indeed now moved to the center and periphery of Europe, in stead of the US, then a close look at the ECB’s policies is not only merited, but quite important.
With the distinct risk of turning this into a cheesy copy of the Oscars show I should thank Edward Hugh for his patient and thorough back-editing of the piece for English language as well as the actual arguments themselves. All mistakes and mishaps naturally fall entirely on my shoulders and criticism should be directed accordingly. I reproduce the executive summary below and the full report is online here where you can view it in Google Docs or download it as a PDF. The analysis includes data up until week 35 (and July for the monthly data). If you want a copy of the spread sheet, please let me know.
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Executive Summary
Is the ECB deploying a variant of Quantitative Easing in any fashion, way, shape or form?
If you are talking about Quantitative Easing senso strictu then my answer has to be a simple and straightforward no. However, if we stop being quite so by the letter of the book, and broaden our definition slightly, then I would strongly suggest that the battery of credit enhancing measures put in place by the ECB when taken together with
the steady increase in securities accepted onto the balance sheet as collateral, do make it evident that the ECB – whether wittingly or unwittingly – has moved into some form of what we could at least call “quasi” Quantitative Easing.
Is the ECB indirectly monetizing the debt issuance of Eurozone governments?
If my initial answer to this question – before actually going through the books – would have been an outright yes, I now feel the need to tread much more carefully on this point, since I have most definitely not been able to conjure up that proverbial smoking gun. In fact, it has proved very difficult to establish any kind of direct link between the amount of funding drawn from the ECB refinancing operations and the purchase of government bonds by the MFIs at the national level.
This is not to say, however, that circumstantial evidence is not available that this process is taking place to some extent, and in some countries. I do believe, for example, that the massive purchase by Spanish MFIs of government bonds in that country does offer prima facie evidence that some such connection may well exist, and thus all I can say at this point is that further research is called for, and especially a much more detailed and discriminating data-mining dig-down.
What are the prospects and possibilities for a viable exit strategy for the ECB from its non-standard monetary policy measures?
The measures collectively known as Enhanced Credit Support are by their very nature flexible. However, if there is anything we have learnt from the operation of monetary policy in Japan over the last twenty years it is that premature exit from the sort of substantial support the ECB is offering only makes matters worse, and in addition
this kind of massive liquidity easing is a lot easier to get into than it is to get out of.
A true economic recovery will inevitably be somewhat selective, and it is at this point that the ECB’s problems will really start, since the recovery will begin in some countries and not in others. To take the extreme case: it will be awfully hard to maintain massive monetary easing for a Spanish economy which remains stuck in an “L” shaped non-recovery if in France headline GDP growth were to start to tick back again towards – say – 2%. Then the real dilemmas which face the ECB will begin in earnest. As such, it is going to be much more difficult for the ECB to instigate that dearly beloved exit strategy than many currently like to believe.
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By Claus Vistesen, on October 13th, 2009
I know that I tend to harp quite a bit about the topic above, but I also trust that my readers by now will be well be used to this. One of the main interesting things about the notion that aging might be related to export dependency is that while it enjoys little, if any, support in the academic literature it seems to have gotten an increasingly amount of momentum in the context of the market discourse. But then again, perhaps this is not so odd after all in the sense that markets, analysts, and commentators would tend to pick up narratives and ideas quite a bit before they get assimilated into the sometimes arcane world of academia, especially in relation to economics and finance.
In any event, it is with an increasing regularity that we can now observe analysts and commentators alike invoke the idea that for example Germany and Japan are indeed dependent on exports to grow.
Personally and in the context of a more wonkish perspective of why we should expect ageing and export dependency to be related, I have had two gos here at Alpha.Sources to explain this. The first was a very wonkish piece taken, to some extent, from my upcoming master’s thesis and the second was a bit less difficult, I hope, and dealt with the specific case of Germany. To cap it off, I have even written a paper on the topic and I am presenting it this Wednesday in Barcelona; here is the abstract.
The primary manifestation of the demographic transition in a modern economic context is through ageing and the primary transmission from ageing to the macro economy is through its effect on saving and investment behavior. These two effects taken together suggest a strong impact from the continuing process of ageing on international capital flows and global macroeconomic imbalances. This paper explores the potential relationship between ageing on a macroeconomic level and the reliance, or outright dependency, on exports and foreign asset income to achieve economic growth. The paper’s argument is both theoretical and empirical. Using a standard overlapping generation framework (OLG) in an open economy context this paper discusses whether the proposed relationship between a transition into old age and dissaving is feasible and desirable (or even optimal?). Finally, an empirical analysis is presented on Germany and Japan to show how these two economies, as the oldest in the world, may exactly be in a state of export dependency.
It is still rough around the edges, but I do believe this to be an extraordinarily important topic and I will work long and hard to fine tune the theory as well as empirical strategy so that the message comes out as clear as possible.
More generally, I was also happy and honoured to read the recent monthly newsletter from the London based investment company Absolute Returns which included a thorough and fine review of my ideas and thoughts on the topic of how ageing affects capital flows. In fact, the author Niels C. Jensen elaborates in some detail on the obvious and relevant question surrounding the fact that while we may all become de-facto dependent on exports as a function of old age, we cannot all export at the same time. Niels rolls out a fine and thorough argument, but especially; I took note of the following in relation to Japan (my emphasis);
No other country is aging as quickly as Japan. Saddled with a large number of old age pensioners already (the dependency ratio is currently 35), the ratio will grow to an astonishing 76 over the next four decades. The Japanese economy has struggled to drag itself out of a slow growth environment for the past twenty years (give or take). The problems in Japan are well publicised and are often blamed on failed policy measures. I just wonder how big a role demographics have actually played in all of this and whether the Japanese mire is a sign of things to come for the rest of us?
I would never be so stupid to argue that policies, culture, as well as institutions don’t matter. They obviously do and are a big part of the picture. However, I also believe that when we come to look at the case of e.g. Japan the demographics, defined by an ongoing and relentless process of aging, tend to crowd out these other factors. This is especially the case when taken so far as it has been in Japan. But then you only need to realize that Niels is right here. Japan is essentially but one step ahead of the rest of the OECD (with a few exceptions), and it is worthwhile to think long and hard about what this means. I am not being a fatalist here, but simply trying to point in the direction of where the real issue is buried since I also believe, without I hope sounding to alarmist, that the stakes are quite high here, not least in the context of policy advice and guidance to the large batch of emerging economies who are destined to follow the same demographic transition as Japan, Germany et al. if we don’t arrive at narrating the issue in a proper way.
Ok, I shall leave it here. Needless to say, that for those of you who are mainly concerned with a P/L (be it yours personally or your clients’) I believe the discussion has relevance too since ultimately ageing is first and foremost transmitted through the flow of factors of which capital flows is, by far, the most important [1]. For that reason alone, Niels’ piece is worth more than a brief look.
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[1] – Migration holds huge potential here, but labour mobility across borders is a whole different ball game than capital.
By Rok Spruk, on October 13th, 2009
This year’s Nobel prize in economics goes to Elinor Ostrom and Oliver E. Williamson (link). Elinor Ostrom received the prize for her analysis of economic governance, especially the commons while Oliver E. Williamson received the prize for his contributions to the economic governance, emphasizing the boundaries of the firm and its role in conflict resolution and case bargaining.
Michael Spence, the 2001 Nobel prize winner, briefly summarized (link) the main contributions of Elinor Ostrom and Oliver E. Williamson to the economic theory.
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