tag:blogger.com,1999:blog-73366485421663941102024-03-19T06:00:59.023-07:00Edward.Hugh.BlogUnknownnoreply@blogger.comBlogger280125tag:blogger.com,1999:blog-7336648542166394110.post-83300498399685410612015-05-18T00:12:00.002-07:002015-05-19T12:39:46.590-07:00Are The IMF and the EU at Loggerheads Over Greece?Everything has a cost, or so the story goes, especially time. In the Greek case we now know an additional item on the mounting bill: the country is back in recession. The issue is who - apart of course from the long-suffering Greeks themselves - will pay the extra costs of the latest imbroglio.<br />
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<h3>
The Cost Of Not Finding A Solution</h3>
<h3>
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It is now clear that Greece's economy has been going backwards over the last 6 months, and that it has once more fallen back into recession. Greek GDP fell by 0.4% in the last three month of 2014, and by a further 0.2% in the Jan - March 2015 period. As a result at the end of March Greek GDP was only 0.3% above the year-earlier level. This is a lot lower than expected in IMF forecasts, and - perhaps more importantly - well out of line with what is needed to maintain the 2022 debt sustainability targets on which continuing Fund support for Greek programmes depends.<br />
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Indeed "Greece is so far off course on its <a href="http://www.ft.com/cms/s/0/520ec4f0-f004-11e4-bb88-00144feab7de.html?siteedition=uk">€172bn bailout programme</a> that it faces losing vital International Monetary Fund support unless European lenders write off significant amounts of its sovereign debt", <a href="http://www.ft.com/intl/cms/s/0/72b8d2ae-f275-11e4-b914-00144feab7de.html#axzz3aHdRghat">Peter Spiegel wrote</a> in the Financial Times on 4 May 2015. The reason for this is obvious: IMF regulations prevent the Fund continuing to make tranche payments to countries where there is a foreseeable financing shortfall during in the coming twelve months. The worsening in the Greek economic outlook and the consequent reduction in the revenue outlook effectively guarantee this shortfall. <br />
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But the sort of debt write-off the IMF is demanding of its European partners goes much deeper than that. Future IMF participation in any new Greek programme <b>after June is also in doubt</b> because without additional pardoning the debt will not be on a sustainable trajectory in terms of the objectives set down and agreed upon in November 2012. So you reach a point where extend and pretend hits the proverbial fan. You can, of course, do more extend and pretend till the next time it happens, but at this point the IMF seems reluctant to do so. On the other hand austerity-type spending cuts which only make the economy smaller and the growth path lower simply don't help in this context, since what they give with one hand (debt reduction) they take away with the other (in the form of lower GDP).<br />
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The background to the current stand-off is to be found in <a href="https://t.co/GXLcHbiOF2">the debt targets the Eurogroup agreed</a> with the IMF in November 2012 and which effectively made the current programme possible. Given the latest recession these targets are clearly now not attainable. On the other hand Greece is totally bust, so the only way the negative effects of the negotiating gridlock can be paid for is by someone else "coughing up" (or rather "pardoning" debt). This someone will need to be the Euro partners (who else is there), and the longer the stand-off goes on the higher the cost. Naturally the other alternative would be allowing Grexit, but arguably the cost of Grexit would be much higher to the Euro partners, and by a large multiple.
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The issue of the growing IMF/Eurogroup divergence came to general public attention over the weekend when an IMF internal memo <a href="http://blogs.channel4.com/paul-mason-blog/imf-leak-signals-progress-greece-threat-default-june/3695">was leaked to Channel 4 News</a> (UK). The key point in the memo, which is hardly news, is that Greece is running out of money. “There will be no possibility for the Greek authorities to repay the whole amount unless an agreement is reached with international partners," referring to a series of June repayments to the IMF amounting to roughly 1.5 billion euros. <br />
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This impression is also confirmed by details of the letter that the Greek Prime Minister Alexis Tsipras wrote to International Monetary Fund Managing Director Christine Lagarde at the start of May (see details in <a href="http://www.ekathimerini.com/4dcgi/_w_articles_wsite1_1_17/05/2015_550106">this Kathimerini article</a>) to inform her that Athens would not be able to pay the 750 million euros due to the Fund on May 12 unless the European Central Bank allowed Greece to issue more T-bills. It appears that at the time of writing the letter (which also went to EU Commission President Jean-Claude Junker and ECB President Mario Draghi) Mr Tsipras was not aware he could temporarily use the 650 million euros held on reserve at the Fund to make the payment, which he subsequently did. It's not unreasonable to assume that it was the IMF itself who advised him on this.<br />
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The inter-institutional tensions are evidently reaching a critical stage, although in fact the issue has now been knocking around for some weeks,<a href="http://www.wsj.com/articles/standoff-between-greece-and-creditors-over-bailout-deal-tests-imf-1429743220"> as Simon Nixon reported in the WSJ</a> on April 22.The IMF, he said, "appears to have blinked".<br />
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<span style="font-weight: normal;">The general impression being given is that the IMF is contemplating a much lower bar for agreement, and then possibly disengagement from any post June programme. The Euro partners are evidently anxious to avoid this outcome, but they are caught between a rock and a hard place.</span><br />
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<h3>
On Or Off The Hook? </h3>
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In order to understand what is going on between the Eurogroup and the IMF it is necessary to go back to a 2013 document entitled: The Third Review Under the Extended Arrangement Under the Extended Fund Facility (what a mouthful that is, henceforth the Third Review). In particular the following paragraph in that document off a key:<br />
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<i>The macroeconomic outlook, debt service to the Fund, and peak access remain broadly unchanged and euro area member states remain committed to an official support package that will help keep debt on the programmed path as long as Greece adheres to program policies. Capacity to repay the Fund thus depends on the authorities’ ability to fully implement an ambitious program. It continues to be the case that if the program went irretrievably off-track and euro area member states did not continue to support Greece, capacity to repay the Fund would likely be insufficient.</i></blockquote>
Now all of this may sound - at least to the uninitiated - like a load of old bureaucratic mumbo-jumbo, but actually there are a number of key statements here which may help to put the current internal Troika tiff in some sort of broader and more intelligible perspective.<br />
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The cited paragraph talks about three issues: the macroeconomic outlook, the commitment of euro area member states to support Greece and keep the debt on the programmed path as long as Greece adheres to the programme's requirements. It also warns of the danger that should the programme go "irretrievably off track", and euro area member states not give the necessary support then the country's capacity to repay the Fund would clearly be insufficient - ie the IMF would be left holding the can, and Fund employees would be faced with the complicated task of explaining to its non-European members why losses had been incurred.<br />
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Crudely put the position is this - as long as the IMF continue to write reviews stating the Greek programme is on track then the euro area member states are <b>on the hook</b> to cover any shortfall in Greek debt performance in order to make the 2020 and 2022 targets (see above) achievable. This is a commitment they undertook during negotiations on the second bailout agreement.<br />
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On the other hand, if the IMF were to start producing reports stating that the programme was <b>off-track</b> because of Greek <b>non-compliance</b>, rather than for example arguing that the numbers were out of whack due to faulty macroeconomic forecasts (and of course the recent economic relapse makes those forecasts even less realistic), then the euro area member states would be <b>off the hook</b> from additional stepping up to the plate with the result that the IMF would end-up taking a loss. <br />
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Well the present recession makes it evident that those targets are even less achievable than they were previously, and that future debt sustainability analyses will have to reflect this. Bottom line: the IMF has a clear interest in enabling Greece to sign successfully off the current programme (due to end in 2016) and they thus have more interest in giving the country a "pass" note than the Eurogroup ministers do.This is why, in Simon Nixon's words, they are blinking, to the great discomfort of the Eurogroup partners.<br />
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<h3>
Bottom Line: When You're Bust, You're Bust</h3>
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A lot of attention is being paid at the moment to the idea that Greece is running out of money, and indeed there is a lot of chuckling about just how much grasp Yannis Varoufakis actually has of game theory. But at the end of the day it is also true that when you have lost everything (in the bankruptcy sense) you have relatively little still to lose. To some extent the idea that the Greek government might be deploying this strategy - known technically as coercive deficiency - was explored <a href="http://russeurope.hypotheses.org/3395">by Jacques Sapir back in February</a>. In my humble opinion far too much energy may have been wasted on laughing at Mr Varoufakis (which might precisely have been his intention) and far too little invested in trying to think through what he might have been up to.<br />
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If delays in negotiations mean a large bill is run up on your credit card (figuratively speaking) at the end of the day you can't pay it, so someone else will have to. This is the situation Greece is now in. If non performing loans start to rise with the new recession eventually these will have to be written off, and the bank recapitalization costs will go on someone else's account. <br />
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The IMF memo in fact draws attention to this issue, and states that “non-performing loans are at very high levels and – going forward – the system might suffer from important stress." Indeed they go further and point out how "staff also noted a dramatic deterioration in the payment culture in the country”. This is what you would expect to find in a country steadily, and day by day, going bankrupt.<br />
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It's no longer clear that even if progress was made in the next two weeks towards some sort of fudged compromise deal - the so called "quick and dirty outcome" that the IMF oppose - that this would be able to get the necessary agreement from all EU parties and the IMF before the June payment. That is not necessarily an insurmountable issue, but it does highlight just how near to a potential brink (or "accident") we are, and it also serves to draw attention to the point that the longer all this goes on the greater the cost for Eurogroup members. Reforms will bring a bit more growth, but only in the longer run. Whatever the package of structural reforms the Greeks sign on to it won't do that much to mitigate the effects of the hit the Greek debt sustainability profile just took.<br />
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But then there is the other alternative - just allow the momentum of the present impasse to carry Greece straight out of the Euro Area. That would solve the problem of getting a deal, but the cost, when you come to think of EFSF and IMF loans plus ELA would hardly be negligible, not to mention the as yet unquantified geopolitical and contagion effects. <br />
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Whatever way you look at it, the next few weeks are certainly likely to be interesting. <br />
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<b>Postscript</b><br />
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The above arguments are developed in much more detail in<b> the recently revised version </b>of my book "<a href="http://www.amazon.com/Euro-Crisis-Really-Over-whatever/dp/1502343436/ref=asap_bc?ie=UTF8"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/dp/B00NKA6PN8">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-65757810389444532072015-05-05T09:38:00.000-07:002015-05-19T12:43:03.828-07:00If Greece Had Not Existed, Europe’s Leaders Would Have Had to Invent Itδεῖ δ’ αὐτὸν ἐς φάρμακον ἐκποιήσασθαι - He must be chosen from among you as a scapegoat. Hipponax<br />
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One of the more intriguing aspects of the whole modern Greek drama is the tragicomic way the country seems to be constantly condemned to live out well known themes which come from its own mythology. The latest example is the way what was once the cradle of European civilization has allowed itself to be converted into the role model for everything its fellow Europeans are not. Or at least, this is the story we are supposed to believe. <br />
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Greek culture and historiography is replete with references to a figure - the pharmakos, or scapegoat – who needed to die that others might live. In fact, the pharmakos ritual is probably as old as human experience itself. In classical Greece it was the custom in times of crisis for some poor unfortunate to be singled out to serve as a whipping boy, the one whose chastisement served to make the wounded demos whole. <br />
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The unlucky victim, according to the texts, was first beaten with fig branches, and then ceremonially led through the assembled community to receive a bout of verbal abuse prior to the execution of sentence, which invariably meant being either sacrificially killed or permanently banished. The whole process has normally been interpreted by anthropologists as the means of purifying the group of some kind of perceived pollution, some sort of plague or great misfortune which has inexplicably befallen them. The source of the evil is first accumulated in the victim - the scapegoat - who is then sacrificed in order that it may in this way be extirpated and the city cleansed.<br />
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According to the nineteenth century British classicist Jane Harrison the pharmakos was viewed as an “infected horror”, even to the extent that the kindest thing might be “to put an end to a life which was worse than death”. The resonance of all this with the recent history of the Euro Area should not be hard to discern. For many Greece has come to incarnate all that is bad within the monetary union. Due to its own laxness it has been transformed into the rotten apple that endangers the rest of the barrel. It needs to be set apart, if need be even expelled. Hypocritically or otherwise some even go so far as to suggest it would be in the country’s best interest to meet this fate, to have Grexit forced on it as an act of kindness, in a way which is all too reminiscent of the arguments used to justify terminating the scapegoat’s suffering . Such a life was, after all, "worse than death".<br />
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The line in the sand that has been drawn around the country is slowly but surely becoming an impermeable frontier. The logical step for the country to take now is "capital controls", or so we often hear, as if such a measure were to help the country remain inside the currency whereas in reality it is the obvious stepping stone on the road to exit.<br />
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Extraordinarily those who are most praised for being "not like Greece" often turn out, on inspection, to be only milder versions of the same. They have debts which are almost as unsustainable as the Greek one (Italy or Portugal), they run far higher fiscal deficits (Spain), they need more labour and pension reforms just like Greece, and without doing more are surely stuck in similar kinds of “growth traps”. Yet far from the others being subjected to harsh austerity and pressure for “tough love” reforms, they are big beneficiaries – without any kind of conditionality – of central bank bond purchases, a backstop for guaranteeing ultra-low interest rates and the kind of market access from which the transgressor country remains frustratingly cut off from. Given that Greece is so obviously the weakest member of the group, what kind of bizarre logic leads the EU’s leaders to impose the most difficult of conditions, especially given how much is at stake for all of us?<br />
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Looked at from a suitable distance it isn’t that hard to argue that if Greece hadn’t existed it would probably have been necessary to invent it. Amongst so many squabbling parties Greece’s presence has served to unite, to let the others know who they are by enabling them to say who they are not. Whatever his shortcomings, the fact that Finance Minister Varoufakis found himself in an 18 to 1 minority in Riga speaks volumes: Greece is the tie that binds.<br />
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So Greece has suffered greatly so that Europe might save itself. And this has now happened twice.<br />
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The first occasion was when the country’s debt was consciously not restructured in 2010, provoking an impossible fiscal adjustment which was inevitably followed by an ultra-deep recession. This decision, as is often noted, allowed Europe’s banks to be saved, while at the same all the other struggling countries had their economies talked up, simply on the basis of their not being "Greece". Indeed the much vaunted European Banking Union is very much a by-product of the Greek travails, as was Draghi’s currency-saving promise. Without the threat of contagion from Greece to support the case for it would this have ever been made?
And now, before our eyes, history is being repeated. The second time is just as much a tragedy as the first one was. Greece is being starved of cash, while everyone else is receiving substantial debt support and enjoying seeing their interest payments reduced to extraordinarily low levels by ECB QE bond buying. Fiscal deficits targets in countries like France, Spain, Italy and Portugal have been relaxed, and in any event no longer attract the investor attention they once did. Everyone wants to ride the Draghi wave, not push back against him. And how exactly was QE pushed so easily through an otherwise deeply divided ECB governing council? It couldn't possibly be because those who were most opposed to it were also those most in favour of forcing Grexit, could it? <br />
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Could there have been some kind of "unholy alliance" between hawks and doves at the central bank since QE put in place the essential "cordon sanitaire" firewall, even while many were busy denying there was any real deflation risk. Naturally it is the presence of this QE firewall which would be absolutely essential to the existential well-being of the common currency should the worst come to pass in negotiations with the new Greek government.
How can it be, at the end of the day, that those who are deemed strongest get most support, while those who are weakest are left exposed – like frail babies in a world long past – to wolves and inclement weather, just to test if they are strong enough to survive before being fed?<br />
<h3>
<b>The First Bailout Enabled a Firewall to Be Built</b></h3>
Greece undoubtedly suffered as a result of the delay in accepting that the country’s original debt dynamic was unsustainable. In fact technical staff at the Fund were convinced of this from the outset, but EU leaders were opposed and from the Greek vantage point critical time was lost. As the IMF explain in their review of the first bailout programme; “An upfront debt restructuring would have been better for Greece, although this was not acceptable for the Euro partners.”<br />
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It would have been better for Greece since it would have enabled the IMF to lend over a longer period, which would have meant that the rate of reduction in the fiscal deficit could have been slower. In plain language the austerity applied would have been less severe, and the economic adjustment more manageable. This is the philosophy being pursued at the present time with the Spanish and French deficits. These two countries are being given longer to bring the overspend down below the critical 3% of GDP stipulated in the Maastricht Treaty, and there is a consensus that this is a good thing.<br />
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An earlier recognition that Greece was insolvent would certainly have helped the Greeks, but it would not have been welcomed by other EU governments who would have had to help their banks – the ones who had been financing the excesses in the first place. "Contagion from Greece was a major concern for euro area members,” the IMF explain, “given the considerable exposure of their banks to the sovereign debt of the euro area periphery.”<br />
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So a programme where there were serious doubts about long term debt sustainability was adopted due to the risk of contagion elsewhere in the Eurozone. The result was that Greece's correction had to be carried out more quickly (or an attempt had to be made to do so) resulting in a much steeper than absolutely essential recession. This way of doing things is not desirable, but even less desirable is to do it, and then fail to accept responsibility for having done so.<br />
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The objective of the line of argument being laid out here is not to support the world view of Syriza or the current Greek government, rather it is to suggest that mistakes made earlier are what has produced a climate in which Syriza-type arguments prosper. Simply to blame the Greeks for this is a travesty. Europe's leaders need to look beyond the current Greek government, and think about the long term interests of the Greeks themselves. Starving the Greek government of cash and crashing the economic recovery - which will only foment more radicalism later - is not the way to do things.<br />
<h3>
<b>How Serious Is Recession Risk Now In Greece?</b></h3>
Getting hard data on Greek economic performance since February is still difficult, since all the important developments are far too recent. However, what information we do have all points in the direction of serious weakening in the economy. Economic sentiment has been falling in recent months, and April's drop was particularly pronounced. The economy contracted in the last three months of last year, and it has surely contracted again in the first three months of this one, making a new recession well nigh a certainty.<br />
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The Greek Parliament Budget Office declared at the end of April that in its opinion Greece was at risk of a new recession. “An agreement with creditors is urgent because the country is in danger of falling into deep recession and the government’s lack of strategy harms the economy”, they say in their latest quarterly report. In fact the economy is almost certainly relapsing and has been in a recessionary trajectory since the last quarter of 2014. Bank deposits have dropped by 26 billion euros since then and outstanding debts to the state have risen by almost 3.5 billion euros in the first quarter of 2015.<br />
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Most businesses are having serious financial problems and huge difficulties with foreign suppliers and clients. Non-performing loans are increasing and the retail sector is suffering, while new investments are almost non-existent. The economy has reached a point where even healthy businesses are in danger, the report says. Some evidence to back this view has also come from the Greek Commercial Register which reported a 21.8% annual drop in new business creation in the first three months of the year.
As the Parliament budget office notes, the economy is starting to suffer from a shortage of cash and liquidity. The banks have suffered a severe deposit loss, and although much of this is covered by emergency liquidity assistance (ELA) obtained via the ECB the fact of the matter is people will be holding on to their hard currency Euros just in case Grexit occurs. This in itself slows activity down.<br />
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But in addition the Greek government itself is short of cash, which means it is not paying suppliers punctually, if at all. Those suppliers then need short term working capital loans from banks who themselves are short on capital, and so on. Basically the economy is suffering a severe cash and credit crunch and it is hard to see how this won't have a severe negative effect on economic activity. The lasts EU Greece forecasts recognizes this state of affairs, and lowers the 2015 GDP growth forecast from 2.5% to 0.5%. More ominously it also raised the debt outlook for this year from 170.2% of GDP to 180.2%. Since Greece is effectively bankrupt this inevitably means more debt pardoning from the country’s Euro Area partners if it is to remain in monetary union. A point which is picked up by the IMF in signs of growing tensions within the Troika itself over how things are being handled.<br />
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Under existing bailout targets, Athens was supposed to run a primary surplus — government receipts net of spending, excluding interest payments on sovereign debt — of 3 per cent of GDP in 2015. But according to the Financial Times, the IMF Greek representatives Poul Thomsen told EU Finance Ministers in Riga that initial data showed Athens was on track to run a primary budget deficit of as much as 1.5 per cent of gross domestic product this year.<br />
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As the FT’s Peter Spiegel puts it: “With the large surplus now turning into a sizable deficit, Greece’s debt levels would begin to spike again. This would force either Athens to take drastic austerity measures or Eurozone bailout lenders to agree to debt write-offs to get Athens’ debt back on a sustainable path. Officials said Mr Thomsen specifically mentioned the need for debt relief during the three-hour meeting.”<br />
<h3>
The Politics of Fear</h3>
The question is, what will be the longer term political consequence of crashing the economy again? The sharp growth in support for Syriza over the last couple of years can be seen as the one of the side effects of an overly deep recession/depression. Sending the Greek economy down further is only going to complicate the political scene even more, and make finding consensus even more difficult.<br />
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Too much EU policy emphasis has been placed on "defeating" Syriza, rather than securing the long term stability of Greece, and its people. Too many EU politicians have even been playing games, using the specter of Syriza to fight domestic populism at home. Naturally the cases of Spain and Portugal come immediately to mind. But does this lack of flexibility serve the long term interest of Europe? Greece's problems are still long term, and can't all be resolved in negotiations between now and June. Releasing bailout money to pay the IMF and the ECB - or rather paying it direct - would have made sense, using these payments as a way of pressuring Syriza by strangling the Greek economy doesn't.<br />
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While growth returned in 2014, it was very modest growth in relation to the fall which preceded it. In addition the country's economy is still suffering from deflation, with consumer prices falling by 1.9% in March over a year earlier, the 24th consecutive month of negative inflation. What the country needs from the EU and the IMF is not a bed of nails, but rather support in moving the economy back onto the path of stronger growth momentum. Rather than treating the country as a scapegoat, as an example of what not to do, Greece badly needs the kind of positive support Portugal, Italy and Spain have been receiving in order to start to attract some constructive investment. All have to serve, but not all are being forced to serve as an example.<br />
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What is needed is not a lesson in morality - from either side - but some plain old fashioned pragmatism. If Greek GDP really does constitute a negligible part of Euro Area GDP where's the big deal? Do US politicians make such a fuss about states like Alabama, or similar? It's in everyone's best interest, and you know it makes sense.<br />
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Greece has already made a very substantial adjustment to its fiscal and external balances. On the fiscal side <a href="http://krugman.blogs.nytimes.com/2015/01/26/internal-devaluation-in-greece/">Paul Krugman estimates it amounts to around 20% of GDP</a> between spending cuts and tax hikes. What a pity if for want of the final nail the whole kingdom were to fall. Greece's has now lost less competitiveness than Finland since the year 2000. This doesn't mean that the one is more competitive than the other, Finland was a lot more competitive at the turn of the century, but it does suggest that the country has made a lot more progress than the anti-Syriza bias in statements on Greece is giving its citizens credit for at the moment. <br />
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Naturally the country "cheated" on its partners, and sacrifices were inevitable but surely a more pragmatic and equitable solution could have been found. Simply punishing a country for what is perceived to have been "wrong doing" on the part of its elected representatives accomplishes little and may put a great deal at risk, including amongst those not directly involved. <b> </b><br />
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<b>Postscript</b><br />
<br />
The above arguments are developed in much more detail in<b> the recently revised version </b>of my book "<a href="http://www.amazon.com/Euro-Crisis-Really-Over-whatever/dp/1502343436/ref=asap_bc?ie=UTF8"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/dp/B00NKA6PN8">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-8318481671019093302015-04-17T09:21:00.000-07:002015-05-19T12:43:39.305-07:00ECB Taper NewsWhat Business Insider's <a href="https://twitter.com/Birdyword">Mike Bird</a> somewhat ironically calls <a href="https://twitter.com/search?src=typd&q=%23euroboom2015">#euroboom2015</a> seems to be well and truly with us. <br />
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The WSJ's Simon Nixon spelled it out for us in his "<a href="http://www.wsj.com/articles/suddenly-qe-becomes-flavor-of-the-month-for-the-eurozone-1429129592">QE is Working Better than the ECB Dared Hope</a>" article: "one month into the ECB’s €1 trillion ($1.06 trillion) quantitative-easing program, and ECB President Mario Draghi was only too happy to take credit for a remarkable turnaround in the economy’s fortunes at Wednesday’s news conference." And he goes on to give examples:<br />
<blockquote class="tr_bq">
"Growth forecasts have been continually revised up since January when the program was announced: the International Monetary Fund said this week it now expects the eurozone to grow by 1.5% in 2015. Business and consumer confidence are the highest since 2007. Bank lending is finally picking up."<br />
<br />
"The strongest growth is coming from former crisis countries: Spain is forecast to grow by up to 3% and Ireland up to 4% this year. Meanwhile German policy makers fret that with growth likely to hit 2.5%, the economy may overheat."</blockquote>
Naturally, as he also says, "not all of this can be traced to quantitative easing." But then, here comes the point: "Indeed, if the ECB had delayed its decision on quantitative easing until March, as the Bundesbank had urged, it may have concluded it didn’t need to buy any bonds at all."<br />
<br />
This is just the issue. There is such a phenomenon as getting too much of a good thing. If you talk up the successes of QE to the nth degree then suddenly it seems its continuation is hardly going to be necessary, since all the good work has already been done. Naturally Mr Draghi is anxious to avoid this conclusion, even if some of his opponents on the ECB's Governing Council are not. <br />
<br />
For the moment the critics are silent, since the possible Grexit eventuality means that tolerating QE is for the time being expedient to protect the rest of the periphery from possible contagion. In fact most of Mr Draghi's critics are also among those who are most favorable to a Grexit outcome.<br />
<br />
Markets are evidently growing increasingly nervous at the lack of a resolution in the EU Institutions/Greece stand-off, but eventually - match point style - the ball will come down on one side of the other of the net. Then we will see that the situation we are in now - which appeared to be so peaceful and full of joy - is actually a very unstable, and very temporary, equilibrium. The initial ECB QE trade is nearly done, and markets are looking for another narrative. Either one of two things can happen: Greece can leave, or it can stay. In the first case QE becomes permanent, since countries like Portugal and Italy also have unsustainable debt burdens, and taking QE off would simply lead to market testing of one or other. <br />
<br />
In the second case, Greece stays in, we will go straight into a taper debate, since the opponents will become more vocal, and the data - as I will explain below - will support them. In this case market reaction is going to be very hard to anticipate.<br />
<br />
<b>Careful With That Monetary Policy Divergence</b> <br />
<br />
Commenting on the outcome of the news conference Anatoli Annenkov, an economist at Société Générale, said it was clear Mr. Draghi’s main goal was to “tone down expectations of an early tapering just because things are going well. He wanted to send a strong signal that QE would continue for some time, and that’s very reassuring for investors:” But this is exactly Mario Draghi's problem at this point, he wants to "tone down" tapering expectations without killing them off completely. <br />
<br />
The main reason the ECB President doesn't want to rule out tapering entirely concerns what is called <b>monetary policy divergence</b>. This relates to the gap between an "easing" stance and a "tightening" one. At the moment, with their extensive QE programs both the ECB and the Bank of Japan are seen as having a strong easing bias, while the US Federal Reserve has a discourse which points to the likelihood of interest rate rises (ot tightening) in a non too distant future. The more Messrs Draghi and Kuroda stress the long term nature of their programs the more they effectively re-inforce this easing bias. The nearer Janet Yellen gets to putting a date on the first rate hike, the more she generates a "tightening" perception.<br />
<br />
All of this is important given that the main channel for inflation/deflation at the moment is the relative currency value one. So Draghi being more doveish tends to weaken the Euro, and conversly "taper talk" tends to strengthen it. This is important since the ECB's medium term inflation expectations are based on a currency level: $1:04 in 2017. Any overshooting on this and the forecast moves up, bringing tapering nearer. Mr Draghi wants to keep the purchases going, all the way through to September 2016, but ironically in order to do this it is important he doesn't appear too doveish: <b>suggesting a tapering debate may take place may be the one - even the only - way of ensuring it doesn't. </b><br />
<h3>
</h3>
<h3>
Does The Euro Area Have a Deflation Problem, Or Doesn't It?</h3>
<br />
<a href="http://edwardhughtoo.blogspot.com.es/2015/03/when-will-ecb-start-to-taper.html">As described in my previous post</a> on this topic, the ECB is committed to a 60 billion Euro a month bond purchasing proposal, which is conditional on achieving a sustained increase in the inflation outlook towards a 2% inflation rate, in the medium term. Period. There is no other objective - not growth, nor unemployment - since these are not in the ECB mandate.<br />
<br />
Naturally, the fact that many people - including several country representatives on the ECB governing council - have never really accepted there was a deflation risk, rather than just a short term dip in headline inflation provoked by a drop in energy prices, is bound to lead to increasing speculation about the immovability of the September 2016 end-date as inflation and inflation expectations start to rebound.<br />
<br />
Perhaps its worth pointing out that examining the potential for short term "taper tantrums" in no way precludes the possibility that whatever happens to the predictable attempts to stop QE early the ECB may in fact eventually find itself caught in the jaws of QE for many years to come. The reason for this is simple: the Euro Area may be suffering from secular stagnation, a possibility the vast majority of ECB watchers and Governing Council members still exclude.<br />
<br />
In the short term, however, the legal basis of the current programme is more tenuous than many imagine, since, as will be explained below, it exclusively hangs on attempting to comply with the price stability mandate. It is also important to understand that the ECB is not the Bank of Japan, not only because it rests on a different institutional base, but because it hasn't been fighting deflation for over 15 years.<br />
<br />
If we look back at the history of the BoJ there had been numerous false starts before Governor Kuroda was actually given the authority to go as far as it took, and damn the consequences. <br />
<br />
Mario Draghi - despite his "whatever it takes" promise - still does not have this kind of political backing, as was evident during the long running debate about whether he would be able to do QE at all. So it is the opinion of this author that the likelihood of a Governing Council which is only half convinced that it is necessary to do what it is actually doing, and which has an inflation- and not a deflation-bias mindset is more than likely to err on the side of a false start at some point in time. The question, really, is when.<br />
<br />
Naturally, and before going any further, it is worth making one more thing clear: if Grexit were to happen, all QE taper bets would be off, since in the aftermath QE would surely be maintained more or less indefinitely, but in that case Mario Draghi which be able to refer to a Euro existential survival argument which he can't use otherwise.<br />
<br />
<b>So Just Who Has Been Provoking the Tapering Debate? </b><br />
<br />
Evidence of a lack of conviction among members of the ECB governing council about the absolute necessity for the current programme given the context of what is seen as the Euro Area economy's strong rebound is widespread. Spain's representative, Luis Maria Linde, for example,<a href="http://www.bloomberg.com/news/articles/2015-04-10/ecb-s-linde-says-negative-yields-won-t-last-as-economy-recovers"> told Bloomberg news</a> recently “I think that perhaps to say now that there is no deflation risk is easier to say than two months ago." "Two or three months ago there wasn’t this feeling. There was a feeling that there was a risk of deflation, he said.”<br />
<br />
ECB Executive Board member Yves Mersch was also out before the last meeting <a href="http://uk.reuters.com/article/2015/04/07/uk-ecb-policy-mersch-idUKKBN0MY1IF20150407">informing Germany's Boersen-Zeitung newspaper</a> that, in his opinion, the bank would be free to adjust its programme if prices moved faster than expected towards its inflation goal. "If we were to see that this process brings us to our goal earlier, then we are naturally not so tied to our decisions that we could not adjust things," he said. This flexibility would apply either way: "In neither direction are we resistant to reality," he told the paper.<br />
<br />
Such remarks were preceded in February by Slovenian central bank governor, and ECB Governing Council member Governor Bostjan Jazbec - always good to be in first - who told <a href="http://www.wsj.com/articles/ecbs-jazbec-qe-could-end-sooner-than-sept-2016-1423134519">The Wall Street Journal</a> even before purchases started that they might end early. “I understand it this way," he said, "Once the price mandate is fulfilled, we can end it earlier.” <br />
<br />
So when Mario Draghi told journalists last Wednesday that he was "<i>quite surprised...by the attention that a possible early exit of the programme is receiving, when we’ve been in this programme only a month</i>," it's not clear who he was referring to, bloggers like me, or members of his own board who have been busying themselves encouraging speculation in the press.<br />
<br />
<b>Marathon Example </b><br />
<br />
A lot of attention has been diverted away from the (possibly tiresome for many) details of what actually went on at the board meeting by the confetti incident, but the ECB President did have to face numerous questions during the presser related to the tapering issue. An outcome hich really, at least on grounds of clarity, is not that surprising. Many of those present were curious to learn, not whether or not tapering was coming at the June meeting - which obviously it isn't - but about what exactly the criteria are for assessing when such a scenario might arise. For those investors currently buying bonds quoted at interest rates below zero you could consider that the issue is one of some importance.<br />
<br />
Curiously, in answering one of these questions Mr Draghi referred to a discussion that, he explained, had taken place during the board meeting (now we await minutes to see more of the substance). One of his colleagues apparently is given to running marathons, and had suggested the current tapering concerns were "like asking yourself, after 1 km, am I going to finish this marathon." He did not, however, report on how Messrs Mersch, Jazbec, Linde et al responded to the comparison.<br />
<br />
What he did inform the journalists was that an extra, clarificatory, sentence had been added to the introductory statement as a response to such concerns. The original wording is first repeated: "Purchases are intended to run until the end of September 2016 and, in any case, until we see a sustained adjustment in the path of inflation that is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term."<br />
<br />
But then wording - "When carrying out its assessment, the Governing Council will follow its monetary policy strategy and concentrate on trends in inflation,<b> looking through unexpected outcomes in measured inflation in either direction if judged to be transient and to have no implication for the medium-term outlook for price stability</b>" - has been added. So we are dealing with trends, not transient fluctuations. Fine. Did anyone ever think otherwise?<br />
<br />
On the use and significance of the word "<b>intended</b>" - which has been the centre of much attention - the ECB President said the following: "Some of you, when I first used the word <b>intended</b>, rather than <b>expected</b>, rightly pointed out the difference between the two concepts" - actually they are words, lexemes or whatever, not concepts, but still Mr Draghi is a banker not a linguistic philosopher - "This was at the beginning of December last year, in an introductory statement where we changed the word, and that was meant, and was accepted by markets, as being a <b>powerful signal</b> of changing the monetary policy."<br />
<br />
So you see, it isn't all boring, at every meeting we learn something. On this occasion we learnt that the change from "<b>expected</b>" to "<b>intended</b>" was a powerful signal about monetary policy. But what does "<b>intended</b>" (as used by the ECB, we will soon need a glossary of terms) mean. Well, let's go back to December: "yes indeed, intended is different from expected. It’s not simply an expectation; it’s an intention, but it’s not yet a target. So it’s something in between."<br />
<br />
At this point we really <b>do</b> need the linguistic philosophers. Maybe we do have a better idea what the ECB president means by a "powerful signal", but I personally have to admit to not being very clear about how exactly "intended" is meant to from "target", Target is something you can aim for but miss. You can intend to achieve a target but still miss it, and you can intend to arrive on time but in fact turn up late. If there was no tapering possibility surely the auxiliary verb <b>will</b> would have been enough, "the programme <b>will</b> continue till <b>at least</b> September 2012." That way there would have been no doubt, or room for speculation. That's the form of words the Bank of Japan Governor Haruhiko Kuroda used, so if the ECB President isn't using it there must be a reason.<br />
<br />
What we are left with, then, is the idea that it is the intention of the ECB to continue purchases until September 2016, but in fact that intention may be modified, in either direction, depending on something else. It's not the same, for example, as promising to continue the purchases till September 2016.<br />
<br />
Cutting through all the long grass here, I think we can safely assume that what Mr Draghi was trying to tell us was that it is the ECB's intention to carry out bond purchases for as long as, but only for as long as, sustained medium term expectations for inflation are not "below, but close to, 2%", and that the September 2016 date is for orientation purposes only. I really don't think there is any room for doubt here: once medium term expectations are perceived to sustainably reach this level, bond purchases will start to be wound down, whether that date be before of after September 2012.<br />
<br />
And what does "medium term" mean? Well, basically this is easier, it means 2 years forward. So currently we are talking about expectations for 2017. Obviously in September 2016 we will be talking about mid 2018, and so on. <br />
<br />
And as I discussed in <a href="http://edwardhughtoo.blogspot.com.es/2015/03/when-will-ecb-start-to-taper.html">my last post on this topic</a>, the main mechanism for inducing inflation here is the exchange rate drop, and even though Mario Draghi wouldn't dream of mentioning an exchange rate target, fulfilling the inflation objective (not target) in 2017 implies a fall in Euro/Dollar to $1.04. Once the Euro starts to fall below that level the risk rises that inflation may go above target over the forecast horizon, and I'm sure Jens Weidemann will be there reminding him of that, all the way through.<br />
<br />
<b>So Why All the Fuss About Such a Byzantine Issue?</b><br />
<br />
Well one reason it is worthwhile paying some attention to all this linguistic juggling might be the one suggested by Mario Draghi himself, since he did point out that no matter how premature the topic "it’s always good to ask difficult questions. It just forces one to think." <br />
<br />
Looking beyond that, there may in fact be one or two more immediate reasons. Just as a starter Spain's first negative bond yield arrived last week. Now I know the country's economy has made great strides in recent months, but is it really so much improved that investors should be willing to pay money to have the privilege of lending to the government, which just by-the-by had the EU's highest fiscal deficit in 2014, and the second highest unemployment rate? <br />
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And Italian bond yields aren't far behind.<br />
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<br />
The real question we should be asking ourselves is if QE were to end, what would happen to these - and Portuguese - yields? They are all ridiculously low in relation to the level of country-specific risk in each case. At the moment they are being held at these levels by the ECB purchases programme. But if the termination of those purchases comes in sight, how will financial markets react? Eventual QE possibilities have been being built in steadily since the "whatever it takes" speech. As a result in the enthusiasm which preceded QE markets have been paying very little attention to "details" like deficit levels, etc. But what happens when you take that QE support away? When the consensus trade becomes a different one?<br />
<br />
So the issue of how long the programme will last is far from being an academic one.<br />
<br />
<h3>
Impact on Policy-making at the Federal Reserve</h3>
<h3>
</h3>
Mario Draghi would never admit it, but his policy - as well as that of the Bank of Japan - is having an increasing impact on the freedom of movement of the US Federal Reserve. Monetary policy divergence is the main driver of lower Euro/USD and increasingly negative bund yields. This is effectively crimping Janet Yellen's discourse space. An early end to ECB QE would surely make the Fed's job a lot easier.<br />
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<br />
The Fed is perceived by markets as being forced to postpone its first interest rate rise in this cycle. One reason for his is the weaker economic growth in the US, which is partly affected by the trade performance, but the higher dollar also makes US inflation weaker, thus undermining one of the principal justifications for raising.<br />
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<br />
<br />
If Janet Yellen does move towards a rate rise, and Draghi maintains a strongly "doveish" stance about insisting on September 2016, then that combination looks guaranteed to send the Euro right down to parity and below. But this, in the process, will raise the medium term inflation outlook, while probably at the same time sending German bunds ever deeper into negative territory. This could effectively force the ECB into tapering, even if the effect might well turn out to be muted in the longer run. As Mr Draghi said, it is illegal for him not to comply with his mandate. In introducing QE this argument worked in his favor, but the point could come where it works against him. Continuing with QE could become illegal, and I don't doubt there will be no shortage of people in Germany only waiting to point this out, in court if need be.<br />
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<br />
<br />
<b>The Possible Shortage of German Bunds</b>.<br />
<br />
The run in to ECB QE saw a massive reduction in bond yields across the Euro Area as investors steadily "priced in" the effect of a long anticipated policy move. That is one of the reasons why most of the impact of QE is seen before its actual implementation (as also happened in Japan) and is what leads to the "semi euphoria" surrounding the initial surge in economic activity. It is also part of the explanation about why the tapering debate takes off so quickly. The main thing - except Grexit - that could counter this would be signs the policy wasn't working which produced speculation the central bank would do more (again as seen in Japan). But in 2015 that looks unlikely.<br />
<br />
Portuguese securities have seen the biggest fall, dropping from a 10 year yield of around 7% in mid 2013 to around 2% currently. Portugal’s 10-year bond yield dropped nine basis points on March 5 (the day the purchases started), to 1.79 percent, while Germany’s fell four basis points to 0.35 percent. By the start of April twenty-eight percent of German bonds within the two- to thirty-year range had yields below the ECB’s minus 0.2 percent deposit rate, according to Moody’s Investors Service, making them ineligible for the QE program. This share was 5 percent when the ECB announced the buying programme in January.<br />
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<br />
As a result Moody’s have warned that the ECB could run out of
eligible bonds for some governments by the end of the year. Asked
about this problem Mr Draghi said such speculation was premature. "<i>To ask about scarcity in the
bond market is really premature. We really don’t see any such
phenomenon. It’s also impossible to answer what would one do in case
something that’s not evident at all were to materialise, and it would be
very difficult to answer this question now.</i>"<br />
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Yet even while saying this, as the WSJ's <a href="http://blogs.wsj.com/moneybeat/2015/04/16/why-did-the-ecb-just-expand-the-range-of-bonds-for-qe/">Emese Barthra points out</a>, the bank actually increased the number of European institutions eligible for bond purchases (<a href="https://www.ecb.europa.eu/mopo/implement/omo/pspp/html/pspp.en.html">you can find the list here</a>, newly added institutions in bold). The ECB programme includes 12% of purchases of non sovereign bonds issued by a variety of European institutions, and as an ECB official official was quick to point out expansion of the initial list was always planned, but still, the timing is curious. Mr Draghi said the bank would not be lowering its deposit rate (which would have made possible the purchase of bunds with a less than minus 0.2% yield), but the bank could change the structure of purchases to increase the percentage of institutional purchases if things eventually got difficult.<br />
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<h3>
Risk Of Bubbles?</h3>
<h3>
</h3>
<span style="font-weight: normal;">Finally, one of the </span>issues which arises in the context of QE programmes is that there is a risk of fueling bubbles elsewhere, outside the government bond sector, and outside the program countries. One of the main mechanisms through which such programs work is via the so-called "portfolio effect". Essentially the central bank forces down interest rates on the long (10yr+) end of government bonds to encourage existing holders to sell (thus realizing capital gains) and move into other, riskier, assets. The composition of the investment portfolios of banks, insurance companies, pension funds etc starts to change making credit more available either across the domestic economy, or abroad. In the latter case the move helps the bank achieve its objectives by weakening the currency (promoting exports) and generating inflation via more expensive imports.<br />
<br />
This is what is steadily happening in one market after another, as bond yields gradually fall below zero. Germany is obviously becoming an acute case with all debt out to nine years now negative, and even the ten year bond looks all set to join the rest.<br />
<br />
Mario Draghi was asked about this issue at the last presser. "We are certainly aware," he told his audience, "that a protracted period of time with very low interest rates is potentially conducive to financial stability imbalances." "So far," he went on to say, "we have not seen evidence of any bubble."<br />
<br />
Not everyone would agree with that. Pension funds in Germany are especially sensitive on the question. One popular asset class being used as an alternative, according to Investment Week, is property. "European property has become a popular asset class as people move up the risk curve," Alban Lhonneur, manager at F and C Real Estate Securities,<a href="http://www.investmentweek.co.uk/investment-week/news/2404133/bond-refugees-seek-safe-haven-in-european-property"> told them in a recent interview</a>. Christopher Iggo, senior manager at Axa Investment Managers put the problem more forcefully. “It is a tax on pension funds because they cannot get the required return,”he <a href="http://www.ft.com/intl/cms/s/0/8c2aef0c-df9b-11e4-a6c4-00144feab7de.html#axzz3X6eErjJr">told the Financial Times</a>. So everyone becomes more risk prone, and starts to buy more problematic assets.<br />
<br />
At the bottom of these concerns are worries about whether or not QE does have any lasting impact on real economy dynamics. The UK and US cases appear to suggest that it might. But this depends on what the problem you are addressing is. QE certainly seems to work in cases of financial instability following a global crisis, ie it can protect against the effects of shocks, but it seems to work less well in longer term, deeper problems like the one from which the Euro Area and Japan are suffering. Thus the balance sheet of pluses and minuses will be different, especially if the underlying issue really is secular stagnation.<br />
<br />
At the end of the day you can understand Reserve Bank of India governor Raghuram Rajan's frustration <a href="http://www.moneylife.in/article/raghuram-rajans-tough-battle-against-bubbles/34956.html">when he went to Frankfurt and complained</a> to his audience: "We seem to be in a situation where we are doomed to inflate bubbles elsewhere." As Larry Summers notes <a href="http://www.moneylife.in/article/raghuram-rajans-tough-battle-against-bubbles/34956.html">in a Financial Times article</a> on secular stagnation:
"In the past decade, before the crisis, bubbles and loose credit were
only sufficient to drive moderate growth". What, one might ask, will be
needed to achieve that "moderate growth" outcome this time round? Perhaps in Europe and Japan we are about to find out. <b> </b><br />
<br />
<b>Postscript</b><br />
<br />
The above arguments are developed in much more detail in<b> the recently revised version </b>of my book "<a href="http://www.amazon.com/Euro-Crisis-Really-Over-whatever/dp/1502343436/ref=asap_bc?ie=UTF8"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/dp/B00NKA6PN8">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-68488148446277339842015-04-14T00:28:00.002-07:002015-05-19T12:45:06.644-07:00Is The Crisis Now History In Spain?Mariano Rajoy is a man who is not shy when it comes to being controversial, as the <a href="http://www.bloomberg.com/news/articles/2015-02-22/spain-said-to-lead-eu-push-to-force-terms-on-greece">storm surrounding his stance</a> over the recent Greek bailout negotiations clearly illustrates (<a href="http://www.globaltimes.cn/content/909651.shtml">and here</a>). So it is perhaps not surprising that he did not notably blush <a href="http://www.theoslotimes.com/the-economic-crisis-is-history-spanish-pm-mariano-rajoy/">when he informed a Madrid audience</a> recently that "In many ways, the crisis is history." Such was the storm that followed that he was forced to at least partially retract the offending phrase <a href="http://www.thelocal.es/20141216/spanish-pm-steps-back-from-crisis-is-over-comments-spain-economy">after a meeting with union officials some four days later</a>. "In many ways the crisis is history, but its consequences are not," he clarified.<br />
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Of course all of this is mainly political rhetoric at the start of what is set to be an election year, but still, it does raise interesting questions. Where exactly is Spain? What is the outlook for the future? Is the country still in crisis, or is it, as Rajoy 2.0 suggests simply suffering from the legacy of an earlier one? These questions are not as easy to answer as they seem at first sight, nonetheless in what follows I will take a shot at it.<br />
<br />
<b> Questions to be discussed below are</b>:<br />
<ul>
<li> has enough been done in terms of international competitiveness to be able to guarantee a "complete" labour market recovery?</li>
<li>to what extent is Spain's housing market really going to recover?</li>
<li>is the external correction complete, or is there more to do?</li>
<li>Spain's population (and especially it's working age population) is in decline, what are the economic implications of this? And what is the long run growth outlook for Spain?</li>
<li>the cost of paying pensioners continues to grow more rapidly than income from contributors - does Spain need another pension reform.</li>
<li>Spain's economy will grow comparatively quickly in 2015, but the ECB is buying Spain government bonds, ECB interest rates are near zero, and the country is running the largest fiscal deficit in the EU. What would Spanish growth look like without the deficit and with a "normalisation" of interest rates?</li>
<li>Spain's sovereign debt is about to pass the 100% of GDP level, will the next government be able to stabilise the debt, or will it continue to grow?</li>
<li>Spain's recovery at present is largely a services and domestic consumption based one. Industry and capital expenditure continue to lag behind. Is this profile sustainable in the longer term? </li>
</ul>
<span style="font-weight: normal;"> The sections on deflation, population ageing and the pensions crisis are summaries of the following earlier posts.</span><br />
<span style="font-weight: normal;"></span><br />
<h3>
<a href="http://Spain's "Good" Deflation?" target="_blank"><span style="font-weight: normal;">Spain's "Good" Deflation?</span></a></h3>
<h3>
<span style="font-weight: normal;"><a href="http://spaineconomy.blogspot.com.es/2015/03/why-is-spains-population-loss-economic.html" target="_blank">Why Is Spain's Population Loss An Economic Problem?</a> </span></h3>
<h3>
<span style="font-weight: normal;"><a href="http://spaineconomy.blogspot.com.es/2015/03/spain-fuelling-todays-retail-sales-by.html" target="_blank">Spain - Fuelling Today's Retail Sales By Spending Tomorrow's Pensions?</a></span></h3>
<h3>
<span style="font-weight: normal;"> </span><b>Spain's Recovery Is Real</b></h3>
The most striking and obvious thing about the Spanish recovery is the way in which real (inflation adjusted) GDP growth rates have steadily accelerated. The country's economy - with a quarterly increase of 0.8% -had one of the fastest growing Euro Area economies in the first three months of 2015. The annual rate accelerated to 2.5%, while full year 2014 growth rate (as compared to 2013, when it shrank by 1.2%) was 1.4%.
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These are good results, but it is worth bearing in mind that everything is relative and that there is still a long hard road to travel. GDP levels still remain around 4.5% below the pre-crisis level. And while the (possibly optimistic) Bank of Spain forecasts are for robust growth in the near future - 2.8% in 2015 and 2.7% in 2016 - even their achievement will mean the pre-crisis level will not be attained before 2017, which gives a very concrete and precise meaning to the term "lost decade". The real debate is about the following decade, whether or not that one will be lost too, as deflation and secular stagnation steadily take hold in the context of an ageing and declining population (see <a href="http://www.imf.org/external/pubs/ft/survey/so/2015/new040715a.htm">the latest IMF report on this</a>, and Larry Summers on Secular Stagnation <a href="http://larrysummers.com/2015/04/01/on-secular-stagnation-a-response-to-bernanke/">here</a>) . Is Spain not at risk of becoming Japan 2.0?<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjnaOgRDcs_jmx81sJ5_dUvKyacS8by74PXDwbhinYhnExyiq74MUguMRoQi980p_lZBUvSBM4cL_azt5QS9RrZKqmyRQgibTjt_qURASfYkZEuzOahhGGywPGPg_mOtNcoI2Tp3-4k8jI/s1600/2015-04-12_193611.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="171" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjnaOgRDcs_jmx81sJ5_dUvKyacS8by74PXDwbhinYhnExyiq74MUguMRoQi980p_lZBUvSBM4cL_azt5QS9RrZKqmyRQgibTjt_qURASfYkZEuzOahhGGywPGPg_mOtNcoI2Tp3-4k8jI/s1600/2015-04-12_193611.png" width="320" /></a></div>
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Certainly there are many in Spain who would deny that possibility, among them Economy Minister Luis De Guindos, who recently <a href="http://www.wsj.com/articles/spains-economic-growth-accelerates-in-fourth-quarter-1422606139">told the Wall Street Journal</a> that he expected growth of between 2.5% and 3% for the next two to three years with the trend simply continuing thereafter. Bank of Spain governor Luis Maria Linde would be another. He <a href="http://www.bloomberg.com/news/articles/2015-04-10/ecb-s-linde-says-negative-yields-won-t-last-as-economy-recovers">recently told Bloomberg reporters</a> that negative interest rates would be a temporary phenomenon which would disappear as the "recovery tales hold" and that it was much easier to "assert there was no deflation risk" in Spain than it had been some months earlier (when he was also saying there was no risk). Such assertions are hard to either agree with or dispute, since no one really knows the future. Words are easy while economic models simply mindlessly churn out predictions based on past performance. The only thing we can be sure at this point is that the future will look less like the past than it ever did, so forecasts based on old data have less validity than ever. At the same time simple economic theory suggests that as work forces decline economic growth rates will do too. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEin_7oAh68gS2UWeVT_q3DeAf0FGwz8iH8sKQuP6-YjS1_idl6Zz6Dc3JfOirhmzZeMWrhw6Xp9xyK-389CkDPPYSWmx3n5F7tJU5W__rnlekk_4pgueuEbkj5jmJbxTrOajxjcwhX_s8E/s1600/2015-01-31_125812.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="192" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEin_7oAh68gS2UWeVT_q3DeAf0FGwz8iH8sKQuP6-YjS1_idl6Zz6Dc3JfOirhmzZeMWrhw6Xp9xyK-389CkDPPYSWmx3n5F7tJU5W__rnlekk_4pgueuEbkj5jmJbxTrOajxjcwhX_s8E/s1600/2015-01-31_125812.png" width="320" /></a></div>
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Still, were the most optimistic forecasts to be confirmed the resulting growth rates over a sustained period would clearly turn the country into the Euro Area's most efficient and fastest growing economy, and it is hard to see where the basis for such confidence comes from. When Spain's economy grew at rates of 3% or more a decade or so ago it was on the back of excessive and unsustainable debt increases, and that isn't going to happen again, even were it desirable. Spain's economy may well grow by more than 2.5% this year (although with deflation nominal GDP will grow by less), but - failing something unexpected like Grexit - it is hard to imagine a more positive growth environment. As for when we get to 2016, as they say, it depends......... <br />
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<h3>
<b>Employment Growth Is Strong As Unemployment Falls</b></h3>
The second area where it is possible to see a strong positive side to Spain's recent performance is on the employment front.According to the latest labour force survey Spain created 434,000 jobs in 2014.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi0BArmRPBnbXQihkszZC2WDhz4B4DhlVkB72EQN6jcAUEfITjegvHCWWPwEGjk1zk7kHMfadGLOEa_Uf0sxZwyabi0y9c2gw0tP9K5GJRK6ezEMKrEJYUMhfyuFnZwTPoriAEsgCKmQMY/s1600/2015-01-31_140013.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="177" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi0BArmRPBnbXQihkszZC2WDhz4B4DhlVkB72EQN6jcAUEfITjegvHCWWPwEGjk1zk7kHMfadGLOEa_Uf0sxZwyabi0y9c2gw0tP9K5GJRK6ezEMKrEJYUMhfyuFnZwTPoriAEsgCKmQMY/s1600/2015-01-31_140013.png" width="320" /></a></div>
To put some flesh on these numbers it should be said that many of the new jobs are part time (40% of new indefinite contracts are p-t), while many others are temporary and not well paid (the economy is increasingly becoming a low value added services one, lead by tourism), but still, Spain's economy is once more creating employment, and that is good news.<br />
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A similar picture emerges when it comes to unemployment which is now steadily falling back, with the seasonally adjusted rate falling to 23.2% in February.<br />
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And the positive news continued in March: registered signings fell by 7.17% year on year.<br />
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A similar picture emerges from the data for affiliations to the country's national insurance system, which were up 416,000 (or 2.3%) in 2014.<br />
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In fact - as can be seen in the following chart showing numbers of social insurance affiliates - the rate of job creation continues to accelerate. <br />
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And this better employment situation is also confirmed by the fact that the economically active population rose in the last three months of 2014, although it was down over the previous December by 44,000. The participation rate rose from 58.03% in Q3 to 58.24% during the last quarter.<br />
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Naturally, putting all this in perspective, the number of unemployed - almost 5.5 million - remains unacceptably high, and the increase in employment needs to be seen in the context of more than 3 million jobs having been lost since the start of the crisis, but still, things are manifestly improving.<br />
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<h3>
Consumer Confidence Hits A Record High in March</h3>
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<h3>
<b>Household Consumption Driving Recovery</b></h3>
As employment has risen and real (inflation adjusted) wages and pensions have increased (since consumer prices have fallen) spending has naturally rebounded: indeed we seem to be in the midst of a mini consumption boom driven by what is perceived as a short term reduction in prices (which look to many shoppers like very welcome discount offers).<br />
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According to the National Statisics Office retail sales rose (in price adjusted terms) by 1% in 2014 as compared with 2013. I stress price adjusted since with consumer falling an annual 1.1% in December and 0.2% across the year the actually increase in cash in the till was less. Perhaps such an increase is not a game-changer, but after a 30% drop any improvement is welcome.However 2015 sales did not start on such a strong footing, with retail sales falling for a second month in Feb. They were down 0.7% vs Jan (when down 0.4% vs Dec). Still due to the strong autumn surge they were still up 2.6% y-o-y.<br />
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Household consumption - which includes a broader range of spending than retail sales, including the government subsidized car sales - had a very strong 2014, and was up 3.9%. It is not clear that this pace can be repeated in 2015, especially if inflation starts to rebound following the Euro devaluation.<br />
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<h3>
<b>Construction Activity Growing Again</b></h3>
Construction activity has also been rising. Output was up 14.4% year on year in January. Quite what is driving this isn't clear, since with a large stock of unsold houses the demand for more at this point (see below) must be limited, but surely there is activity involved in completing unfinished buildings, of which there are more than a few. Again, this is (in theory) election year so infrastructure spending is probably increasing.Well again, peak to trough was something like 60%, so the rebound could have been anticipated.<br />
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<br />
<b>IBEX on a Roll?</b><br />
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The financial sector has been one of the principal beneficiaries of the
Spanish recovery, thanks largely to the hard work of Mario Draghi at the
ECB. Many will remember <a href="https://www.youtube.com/watch?v=F1OoNOU0_QY" target="_blank">the immortal words of the late Emilio Botín</a>:
"Es un momento fantástico para España, llega dinero de todas partes."
("This is a fantastic moment for Spain, it is literally raining money
from all corners of the globe" October 2013). As a result the IBEX had a
very good 12 months from July 2013 to July 2014 (up maybe 35%) but in
the second half of last year struggled to stay over the 10,000 level. QE
from the ECB will likely be a positive for the index in 2015.<br />
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<h3>
Negative Bond Yields Arrive</h3>
The Draghi QE effect has long been making itself felt right across the Euro periphery, and Spain's bond yields are now constantly breaking historic lows. The 10 year yield has more than halved over the the last 12 months and is now at 1.39% (and falling). Naturally these lower yields will make government interest payments lower (and indeed due to seigniorage repayment will even become zero on those bonds purchased as part of the ECB programme). This benefits everyone, but beyond this the IBEX boom and the increase in bond values which accompanies the drop in yields has made a lot of money for some people, even though these people are a small minority of the Spanish population (indeed they have often been external investors). This means on the one hand that the Spanish net external debt has risen, while on the other those who have suffered most during the crisis feel even more aggrieved that they have been left out of this particular party (the Podemos effect). <br />
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It's possible every time Mariano Rajoy opens his mouth to declare "victory" he probably only ends up alienating yet another group of people who feel they are missing out on the "good times". Certainly this is what the government opinion surveys suggest. In March 41.8% of those asked thought the economic situation was "bad", and 33.8% thought it "very bad", while only 1.8% replied it was "good", and 21.6% "passable". So I think it is reasonable to say that ordinary Spanish citizens do not buy the very bullish arguments being offered by the government at this point, and this is also being reflected in the opinion polls. As most political observers note, economic recovery should help the PP, but first the PP have to convince a skeptical populous that this recovery is real, and that talk about it is not simply another attempt to lead them up the garden path.<br />
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<h2>
Now For The Glass Half Empty Part</h2>
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<h3>
How "Good" is Spain's Deflation?</h3>
In my opinion deflation is one of the serious problems potentially clouding the economic outlook in Spain, as I explain in my <a href="http://spaineconomy.blogspot.com.es/2015/02/spains-good-deflation.html" target="_blank">Spain's "Good" Deflation</a> post. Since I have gone through all the arguments in great detail there I won't repeat myself here.<br />
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I would just note that the argument that Spain is simply suffering the impact of a negative oil price shock doesn't hold up, since as the chart below suggests, once you strip out tax impacts and energy, Spain has been flirting with deflation since the start of 2012.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQhGLTQJ_tb3AjGSv-zV7h7OyIQsMEZYr1ggW3gFAqrpuh5uWsrDUXdS9UlWYZhd07rhfnf7VXtDf5tn-3dPy_fvIxEeROXjYNXcScpyGTkj69PZHfO3rqiyQTrtw0ZzaW87ANOjCnZ-w/s1600/2015-02-22_125722.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="166" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQhGLTQJ_tb3AjGSv-zV7h7OyIQsMEZYr1ggW3gFAqrpuh5uWsrDUXdS9UlWYZhd07rhfnf7VXtDf5tn-3dPy_fvIxEeROXjYNXcScpyGTkj69PZHfO3rqiyQTrtw0ZzaW87ANOjCnZ-w/s1600/2015-02-22_125722.png" width="320" /></a></div>
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It is also clear that there is no short term purchase postponement effect, in fact we can see evidence across countries that as prices fall people buy more. This is largely because they do not expect deflation, and simply take advantage of what they see as "temporary" sales offers and discounts to buy. As very low to negative inflation extends across time the risk is that people come to expect constant and renewed discounts, forcing prices even further down. This is the short term self-reinforcing component.<br />
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It is also the case that up to now prices have fallen, but wages and pensions have not been reduced proportionally. If and when this starts happening the impact on consumer confidence may be the opposite of the one we are now seeing.<br />
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In general, as long as incomes don't fall the growing debt burden problem isn't operative, since debt to income levels don't change, it's only as incomes fall, and over extended periods of time, that this impact starts to make its presence felt. <br />
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<h3>
Is There a Recovery In The Housing Market?</h3>
Spanish housing offers us a clear example of something whose price has fallen considerably, around 40% since the 2007 peak, and whose price continues to fall (in the 3% to 5% per annum range).<br />
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Yet far from this fall in prices having stimulated demand we are witnessing the opposite effect: demand has collapsed, and is not recovering significantly (see my piece from April 2014, "<a href="http://edwardhughtoo.blogspot.com.es/2014/04/firmly-anchored-expectations-no.html" target="_blank">Firmly Anchored Expectations, No Postponement of Purchases?</a>"). The number of new house purchased in December was just over 7,000. That was the lowest monthly level in more than a decade.<br />
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True, the number of second hand houses is rising, but even the combined total is far from showing a sharp rebound.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhf4Fru_03YOivYqeexBW63pey9zsCVZ2QAYpU7Ayto9m_AK9_YWOe7C90ilhm0artIKH8epXG3w1dsSNk-zA875LGRKfFShfU_sLydnhM_2ajmxqNk5CYxs5MjFacDHhxw970Q9nX3E4w/s1600/2015-02-10_093425.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="187" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhf4Fru_03YOivYqeexBW63pey9zsCVZ2QAYpU7Ayto9m_AK9_YWOe7C90ilhm0artIKH8epXG3w1dsSNk-zA875LGRKfFShfU_sLydnhM_2ajmxqNk5CYxs5MjFacDHhxw970Q9nX3E4w/s1600/2015-02-10_093425.png" width="320" /></a></div>
Perhaps the most worrying thing about the fact that second hand purchases are improving while new ones aren't is that part of the explanation for this is that properties become reclassified as "used" 2 years after completion (so some of the second hand houses are in fact new), but this makes the situation with new houses deeply preoccupying since there are nearly half a million unsold housing units still classified as "new" (see <a href="http://www.idealista.com/news/inmobiliario/vivienda/2015/01/12/733817-la-realidad-de-por-que-se-venden-menos-viviendas-nuevas" target="_blank">this article</a> on the Spanish property website Idealista) which means they have - by and large - been built within the last two years. According to the construction manufacturers association Cepco the number of new housing units which had been neither sold nor let at the end of 2014 stood at 439,617.<br />
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The housing market is obviously stabilizing but that is not the same thing as returning to real growth, especially as far as house prices are concerned. There are two reasons for thinking that the recovery will be very weak. The first of these is the growing custom among young people to rent rather than buy. But the second is even more important: Spain's population, especially in the 25-40 age group is falling and each generation is now smaller than the previous one. <br />
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<h3>
<b>From an Export Lead to an Imports Driven Recovery?</b></h3>
<b></b>Exports went through a "soft spot" in the middle of 2014, but recovered towards the end of the year. Price deflated goods exports were up 4.7% in the year to December in comparison with the same period in the previous year. Deflation in Spain (export prices were down an annual 1.1% over the same period) and the weakening Euro are obviously helping. Tourism is also doing well, and income from this activity rose by about 3.4% in the year to January (when compared with the previous 12 months).<br />
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Nonetheless, it is no longer true to speak of Spain's recovery as "export driven" since the growth in domestic consumption has lead to a surge in imports, and the goods trade balance has weakened accordingly, meaning that when it comes to GDP levels net trade is now a negative factor (see below). This issue will come back to haunt us, since with the population falling, the government reducing the fiscal deficit and the private sector not increasing its appetite for credit domestic demand cannot continue to drive the economy indefinitely.<br />
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<h3>
External Balances Worsening?</h3>
While external demand had been making a positive contribution to Spanish economic growth from early 2010, the second quarter of 2013 saw a major shift, with net trade becoming negative, at the same time as domestic demand became a positive factor. Thus the recent recovery is almost entirely due to growth in domestic demand (and growing imports) despite the fact that exports have held up well, and continue to grow to new highs.<br />
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The level of Spanish exports is constantly higher, but exports only contribute to GDP growth insofar as they grow, and this rate has been falling steadily since the post crisis peak. As such the contribution of exports to growth becomes less and less.<br />
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<br />
On the other hand the current account balance, after deteriorating in 2013/14 has been improving since mid 2014 thanks largely to the drop in oil price and the impact of the falling Euro on income Spanish residents (including corporates) derive from their non-Euro overseas holdings (USD investments are worth more in Euros after the devaluation). <b></b><br />
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However the fund inflow that has accompanied the boom in Spanish bonds and stocks has meant that the net external debt balance has again deteriorated. In fact the Net International Investment Position now stands at nearly 100% of GDP negative. This is not a good development, or sustainable. Spain cannot both deleverage and have positive net fund inflows. The long term numbers don't add up. In the short run the inflows are financing the government's fiscal deficit.<br />
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But since interest rates are lower in Europe than in many other parts of the world, the net income stream has actually improved since foreign investors earn relatively little on their Spanish asset holdings, and mainly are benefiting from capital gains. Nonetheless Spain has clearly made a massive improvement in its current account balance which is a big positive for the economy.<br />
<h3>
Industrial Output Lags Behind GDP</h3>
Spain's economic recovery
is no longer export lead, and it isn't industry based either. Industrial
output, as can be seen from the chart, has hardly budged since the
return to growth began, and was only up 0.6% compared with a year
earlier in February. To get a sustainable recovery Spain needs industrial (and not just services) growth.<br />
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<h4>
<b>And Let's Not Forget the Fiscal Deficit</b></h4>
Spain's leaders are very proud of the country's recent growth performance, they also like to claim that it is largely due to their ongoing austerity policy. What they don't mention so often is that the country ran the largest fiscal deficit in the EU in 2014 (5.7% of GDP) and will do the same in 2015 (around 4.5% of GDP). In fact Spain's deficit objectives have been relaxed a number of times in recent years, so far from the outcome being a victory for austerity it is more like a victory for leaving extra stimulus.<br />
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Between falling prices, high fiscal deficit, ultra low interest rates and strong external fund inflows it would be surprising if Spain weren't doing well at the moment. A bigger test will come as all these positive tailwinds start to change direction. Spain probably be running a primary (before interest payments) budget surplus before 2017 - Greece, it will be remembered, is being asked to run one of between 3% and 4% of GDP. If Spain does eventually manage to run a primary surplus it will indeed be interesting to see what the growth rate is. In the meantime the sovereign debt level will pass 100% of GDP this year, and will continue to increase.<br />
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<h3>
<b>Economic Consequences of Demographic Decline</b></h3>
<h4>
The Price Of Doing Nothing</h4>
<br />
The social and political risks associated with Spain having conducted a far from complete economic adjustment are now becoming apparent, but there are also long term economic consequences, ones which may not be very evident at this point. People are often too busy celebrating a short term return to growth to ask themselves the tricky question of where all this is leading.<br />
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The most obvious result of having such a high level of unemployment over such a long period of time - Spain's overall rate won't be below 20% before 2017 at the earliest - is that people are steadily leaving the country in search of better opportunities elsewhere. Initially this new development was officially denied, and since there is little policy interest in the topic we still don't have any adequate measure of just how many young educated Spaniards are now working outside their home country. Anecdotal evidence, however, backs the idea that the number is large and the phenomenon widespread. All too often articles in the popular press are misleading simply because journalists have no better data to work from than anyone else. On the other hand work like this from researchers at the Bank of Spain (Spain: From (massive) immigration to (vast) emigration? - 2013) only serves to illustrate how little we know, especially about movement among Spanish nationals.<br />
<br />
On the other hand, when it comes to migration flows among non Spanish nationals we do have a lot better quality information due to the existence of the the municipal register electronic database. Everyone who wishes to be included in the health system needs to register with it (whether they are a regular or an irregular immigrant), and non Spanish nationals need to re-register with a certain frequency (so the authorities know if they leave). <b>For a fuller discussion of the economic issues raised by Spain's population decline see my post "<a href="http://spaineconomy.blogspot.com.es/2015/03/why-is-spains-population-loss-economic.html" target="_blank">Why Is Spain's Population Loss An Economic Problem</a>".</b><br />
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<h3>
<b>Current Level of Pensions Not Sustainable</b></h3>
The average pension paid is also rising. In February 2015 the total amount paid out by the system in pensions was up 3.1% year on year. But the number of pensioners was only up 1.3%, so the average pension went up by 2.1% due to the fact that the most recent retirees have been earning more than earlier cohorts and are thus entitled to higher pensions. We don't have data on this year's pension system income yet, but at the end of last year it was rising at about 1.5% a year, leaving a growing shortfall for the system to cover.<br />
<br />
As I said, under the former PSOE the shortfall was funded out of the general government budget, and possibly 1.5 percentage points of the 9.6% 2011 fiscal deficit were the result of this financing. With the arrival of the PP in government this policy changed, and pension financing moved over to the Reserve Fund.<br />
<br />
The attrition has been constant and the Fund is now starting to dwindle. In 2012 7 billion euros were withdrawn, in 2013 it was 11.6 billion euros and in 2014 15.3 billion euros (or 1.5% of GDP). If you want to compare apples with apples and pears with pears, you would need to add this 1.5% of GDP to the 5.6% fiscal deficit, giving a 7.1% deficit using the same accounting criteria as 2011. Put another way the deficit has really been reduced from 9.6% to 7.1% in 3 years, hardly dramatic austerity. Instead of paying the pensions gap out of current income the government are using a credit card issued by "future pensions" to keep payments up even though the situation is obviously getting worse, meaning it will be even more difficult to pay current pension levels in the future than it is As a result of all these withdrawals the size of the Reserve Fund has fallen from its 66.8 billion euro peak in 2011 to the current level of 41.6 billion euros. At the moment the government have budgeted for another 8.4 billion euro withdrawal this year, but this number could easily turn out to be larger. So 2015 should close with around 30 billion euros outstanding - about 3 years more money at the current rate. It is clear that soon after the election changes will have to be made. Even though the number of contributors to the system is growing as the employment situation improves the rate of spending is rising faster.<br />
<h3>
<b>Financial Sector Deleveraging or Less Solvent Demand for Credit?</b></h3>
<b><br /></b>Mario Draghi understands that falling inflation expectations raise
real interest rates by influencing the perceived cost of credit into the
future. If consumers anticipate inflation, then that makes borrowing
cheaper and people tend to advance purchases. Conversely expected price
falls make the cost of borrowing greater, make the desirability of
advancing purchases via credit less, and in this sense constitute
monetary tightening. I am aware of an ongoing debate about whether
interest rates really are a key factor influencing investment decisions,
but I have never seen an argument suggesting that the cost of credit
does not influence consumption. And so it is in Spain, since the demand
for household borrowing is not surging, even though the country's banks
keep telling us they are now "<a href="https://twitter.com/bloombergtv/status/558180122055176192" target="_blank">ready to lend</a>".<br />
<br />
I am aware of an ongoing debate about whether interest rates really are a key factor influencing investment decisions, but I have never seen an argument suggesting that the cost of credit does not influence consumption. And so it is in Spain, since the demand for household borrowing is not surging, even though the country's banks keep telling us they are now "ready to lend".<br />
<br />
In fact lending is still falling, and was down an annual 3.2% to the private sector in February. There may be many reasons beyond the strength of bank balance sheets which may explain why we are not seeing an increase in private sector credit in Spain. Some may simply not be able to get loans because they already can't pay their existing debt. The 4 million Spaniards currently on the credit blacklist run by credit consulting firm ASNEF will have a hard time joining in the current consumer "boom" even if they have a job. Spain's Economy minister Luis De Guindos put quite graphically when he said: "It’s hard not to defer purchases when you’ve got no money for them in the first place. In the case of Spanish unemployed I think they’ve got more worries than waiting for a new sofa suite to drop by €50."<br />
<br />
So part of the reason for the "no credit expansion" is the high level of existing debt and the large number of unemployed or people working in low pay short-term contract jobs. Many corporates are also still heavily indebted, and those that aren't are still facing comparatively low levels of demand for their products, which means they will not be engaging in large scale investment projects, which anyway they would probably finance via the bond markets.<br />
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<h3>
Political Uncertainty Ahead</h3>
When the IMF said last year that Spain's unemployment level was unacceptably high, I was pretty critical of the fact that they didn't spell out the consequences of this, or offer any substantial policy alternative. The most obvious impact of this failure to find an alternative is being seen right now, with the emergence of political movements which could well turn the country's two party system completely upside down, and the steady flow of talented young people out of the country in search of work.<br />
<br />
According to the latest Metroscopia opinion poll carried out for the newspaper El País ( April 12 2015), four parties (Podemos 22.1%, PSOE 21.9%, PP 20.8%, and Ciudadanos 19.4%) are in close competition for first place in the forthcoming election. The lastest arrival on the national political scene is Citizens (Ciudadanos), a movement which despite being difficult to pin down in terms of specific policy, seems to lie somewhere to the centre right, between PP and PSOE in terms of its political ideology. It is very hard to predict what the outcome of the coming general election (due at the end of this year) will be, but it seems clear that no one party will have a majority. So governmental arithmentic is about to get complicated.<br />
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The first indication of what the political landscape might start to look like should come in Andalusia, which has regional elections on March 22. Then in May there will be regional elections in Madrid and Valencia, and municipal ones in large cities like Madrid, Valencia and Barcelona. Such elections will, however, only give a vague impression, since personality factors and local loyalties will also be important.<br />
<br />
As for the concerns which are driving this earthquake, these are clear enough from the opinion surveys: unemployment, corruption and the issues related to their current economic situation are by a long way the most important issues in voters minds, indeed despite all the talk of recovery the vast majority of them continue to think the current economic situation is either bad (41.8%), or very bad (33.8%).<br />
<br />
Forthcoming alliances are hard to predict. Ideologically Podemos and Citizens may seem far apart, but the voter concerns which are driving their rise are often surprisingly similar, even if the solutions they offer are quite different. Over the corruption issue, for example, the possibility must exist of a de facto alliance between the two movements to force major reform on the two "traditional" parties.<br />
<br />
Another issue which will probably unite them is that of debt. Many of Spain's citizens are badly indebted, and many still have difficulty paying their mortgages despite very low interest rates. In addition there is the notorious "full recourse" rule, which means people who can't pay can't simply return their home and liquidate their debt. There is a wide feeling of injustice associated with the fact that property developers received limited liability mortgages (many of which have now ended up with bad bank Sareb, with losses being met by taxpayers) while ordinary citizens were given no such "escape clause". "Rescue the citizens not just the banks," is a slogan you often hear these days.<br />
<br />
It is unclear what Citizens propose to do about the issue, but Podemos's opinion is clear enough, and on this stance they enjoy widespread popular support, going well beyond those who will actually vote for them: they will revoke full recourse. It's not a mere detail that the point Pablo Isglesias stressed in his interview with CNBC's Michelle Caruso-Cabrera was, "we can have governments that work for people and not for the banks," As the interviewer commented, "One thing he's really got going for him is ... that in Spain they can kick you out of the house and you still keep paying the mortgage. It's a recourse loan".<br />
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The other big issue is austerity. Spain still runs a large fiscal deficit - 5.6% of GDP in 2014 - the largest in the Euro Area. At first glance, with so many elections taking place it doesn't seem likely this will come down that much this year, and in 2016 it is hard to imagine there won't be a parliamentary majority in favour of prioritizing bringing down unemployment over reducing the deficit, making some sort of clash with the EU commission not improbable. Nevertheless, as long as ECB QE stays in place investors are hardly going to worry too much so yields wouldn't necessarily be affected. But what if the ECB wanted to taper at some point? <b> </b><br />
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<b>Postscript</b><br />
<br />
The above arguments are developed in much more detail in<b> the recently revised version </b>of my book "<a href="http://www.amazon.com/Euro-Crisis-Really-Over-whatever/dp/1502343436/ref=asap_bc?ie=UTF8"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/dp/B00NKA6PN8">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-78843586337934549902015-03-27T09:54:00.001-07:002015-03-28T03:50:23.600-07:00Is Finland's Economy Suffering From Secular Stagnation?<blockquote class="tr_bq">
"<i>After the Great Depression, secular stagnation turned out to be a figment of economists’ imaginations........it is still too soon to tell if this will also be the case after the Great Recession. However, the risks of secular stagnation are much greater in depressed Eurozone economies than in the US, due to less favourable demographics, lower productivity growth, the burden of fiscal consolidation, and the ECB’s strict focus on low inflation</i>."<br />
Nick Crafts - Secular stagnation: US hypochondria, European disease? - In Secular Stagnation: Facts, Causes and Cures, Edited by Coen Teulings and Richard Baldwin </blockquote>
Finland's economy has been attracting a lot of interest of late. And not for the right reasons, unfortunately. The economy in a country previously renowned for being highly placed in the World Bank's "<a href="http://en.wikipedia.org/wiki/Ease_of_doing_business_index">Ease of Doing Business Index</a>" has just contracted <a href="http://www.reuters.com/article/2015/03/02/us-finland-gdp-idUSKBN0LY0U120150302">for the third consecutive year</a>. Once famous for being a symbol of "ultra competitiveness" (it came number 4 <a href="http://www.weforum.org/reports/global-competitiveness-report-2014-2015">in the latest edition</a> of the WEF Global Competitiveness Index) the country is now fast becoming the flagship example of another, less commendable, phenomenon: secular stagnation.The origins of the theory of secular stagnation go back to the US economist Alvin Hansen (<a href="http://conversableeconomist.blogspot.com.es/2013/12/secular-stagnation-back-to-alvin-hanson.html">see here</a>) who first used the expression in the 1930s. The hallmark of secular stagnation, he said, was a series of sick "recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment." This seems to fit the Finish case to a T.<br />
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After the global crisis the economy seemed to recover, but after the second Euro Area recession the country's economy hasn't been able to lift its head again.<br />
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In fact GDP still languishes about 5% below the 2008 peak.<br />
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Unemployment, on the other hand, has remained stubbornly high, and - at 9.1% - has recently passed just above the crisis peak.<br />
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Hansen surmised that the big driver of US economic growth prior to the 1930s had been population growth. Given the fact that he expected US population to fall he, not unrealistically, came to the conclusion that "We are thus rapidly entering a world in which we must fall back upon a more rapid advance of technology than in the past if we are to find private investment
opportunities adequate to maintain full employment. ..."
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He thought technological advance could stimulate investment to fill a gap left by the lack of natural investment growth. Following Adam Smith he recognized that the "rate of investment" is conditioned by the extent of the market (or rather the rate of expansion of the "extent of the market"), but if population was falling rather than rising then the incentive to invest like before wouldn't be there, since the market wouldn't be increasing in "extent". So technology and innovation became more, not less important, just like the situation we face now.<br />
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Hansen was wrong about the demographic dynamics - he didn't foresee the post war baby boom, but then neither did the demographers he relied on. (For more on this see Richard Easterlin,"<a href="http://books.google.es/books/about/The_American_baby_boom_in_historical_per.html?id=kCDwAAAAIAAJ&redir_esc=y">The American Baby Boomin Historical Perspective</a>", 1962). But if we look at the situation we face today there is a lot less uncertainty about the population outlook over the next 10 to 20 years, especially when it comes to working age population dynamics. From the experience in Japan it seems it is working age population and not total population that really matters in terms of macroeconomic effects. Declining inflation/deflation correlates much more strongly with working age population dynamics than it does with monetary policy.(See Bank of Japan former <a href="http://www.boj.or.jp/en/announcements/press/koen_2012/data/ko120530a1.pdf">Governor Masaaki Shirakawa here</a>).<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEifc6ezCQfmWW9-u1YCb0X42aHUivMA3-HSz1a4dH2KssBnFAfma6-82r6q85E1zotPegAHRtCMlIU7hyphenhyphenPJ66sOPOnNN0fQYS4JcMQkqGadGexQpFT7HlivXXBaVJW5fQ8G2AJ1dVLSStA2/s1600/Japan+Population+and+Inflation.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEifc6ezCQfmWW9-u1YCb0X42aHUivMA3-HSz1a4dH2KssBnFAfma6-82r6q85E1zotPegAHRtCMlIU7hyphenhyphenPJ66sOPOnNN0fQYS4JcMQkqGadGexQpFT7HlivXXBaVJW5fQ8G2AJ1dVLSStA2/s1600/Japan+Population+and+Inflation.png" height="320" width="317" /></a></div>
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In fact, Finland's working age population peaked during 2010, and it has since been declining rapidly. So it fits the picture described by Hansen admirably.<br />
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And indeed the Finnish economy is now starting to flirt with deflation.<br />
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<span style="font-size: large;"><b>Loss Of Competitiveness.</b></span><br />
<blockquote class="tr_bq">
"Finland’s economy has fallen behind its Nordic neighbors and euro peers, in what Prime Minister Alexander Stubb has called a “lost decade.” Pay increases are on hold after a wage boom during Nokia’s glory days opened up a salary gap of about 20 percent with the country’s main trading partners, Sweden and Germany.
“We need to bridge the cost gap with our competition,” said Jyri Hakamies, who heads the Confederation of Finnish Industries, the main business group. “That will take years. At the same time, labor agreements must be made more flexible and productivity must improve to kick-start economic growth and create jobs”"<br />
Bloomberg News: <a href="http://www.bloomberg.com/news/articles/2015-03-26/nokia-fueled-boom-years-leave-finnish-workers-with-stagnant-pay">Nokia-Fueled Boom Years Leave Finns With Stagnant Pay </a></blockquote>
In 2007, when the countries export-led technology industry was booming workers representatives hammered out an 8.5 percent wage increase that was implemented over two years. That deal led to an upward spiral where other industries and then the public sector pushed for ever higher compensation. As a result of agreements like these unit labor costs have been growing sharply for more than a decade. They diverged from levels seen in Sweden and Germany in 2007, just as the woes of Nokia and the paper industry intensified and exports slumped.<br />
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Since 2008, Finland has lost competitiveness against all EU countries as its wage costs have rocketed. As the unit labour costs of Ireland and Spain have fallen, Finland’s have increased by about 20 per cent. Productivity has suffered correspondingly. The Conference Board calculate that from 2007 to 2012 Finland’s unit labour costs in manufacturing rose by 6.3 per cent a year, faster than any of the countries surveyed except Australia and Japan. At the same time, Finland’s productivity fell by 3.9 per cent a year, far more than in any other country. Richard Milne (<a href="http://www.ft.com/intl/cms/s/0/35c8560c-c62f-11e4-add0-00144feab7de.html#axzz3VfOZYz4G">in an FT Op-Ed</a>) produces the following chart to illustrate the situation.<br />
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The chart is slightly misleading, illustrating just one more time how there is no such thing as an economic "fact", since he has rebased the index to 2007, just when Spanish unemployment started to rise much more rapidly than measured GDP fell, provoking a substantial downward adjustment in ULCs. So Spanish and Finnish ULCs have seriously parted company, but not by as much as the chart suggests, since in 2007 Spain's ULCs had grown to absurdly high levels.<br />
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Just to illustrate how in a pre-scientific, ideologically divided discipline like economics there are no (consenual) facts, only interpretations, I have rebased the ULC data to 2000 in the chart below. This still shows how serious the Finnish situation is, but puts the Spanish development in a rather different light. Finland wasn't THAT uncompetitive until 2011.<br />
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In fact Finland has transited from being a country with a significant goods trade surplus, to being one with a structural deficit.<br />
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Even the current account balance has now turned negative.<br />
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And the country's Net International Investment Position is also turning negative. This is an especially worrying phenomenon in the case of a country with a rapidly rising elderly dependent population, as income from external investments can help maintain living and welfare standards. Net negative income payments will only leave less money available for social policies.<br />
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<span style="font-size: large;"><b> Housing and Consumption Boom</b></span><br />
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As in earlier similar cases, the loss of competitiveness and export prowess was compensated for in the short run by a modest consumption and housing boom. House prices rose sharply - possibly helped by the availability of low interest mortgages driven by ECB monetary policy - from 2008 to 2013. But now prices have begun to stagnate, and even decline slightly.<br />
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The number of building permits issued has slumped.<br />
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While the rate of demand for new mortgages has been steadily dropping off.<br />
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<span style="font-size: large;"><b>What To Do About The Situation? </b></span><br />
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The whole topic of secular stagnation is a highly controversial one at the present time. In the first place there is no general agreement that this is what is affecting a country like Finland. Those, like Prime Minister Alexander Stubb <a href="http://www.bloomberg.com/news/articles/2015-02-12/finland-grim-choices-in-national-election">would argue</a> that it is simply a question of the country having lived beyond its means, and hence lost competitiveness. Thus, in his opinion, what it now needs is a lengthy process of internal devaluation and austerity. Curiously - in a country that was busy recommending sharp austerity to others - he blames rising debt and lax fiscal policies for the situation. Finland's economy could flat-line through the 2020s, <a href="http://www.reuters.com/article/2015/03/24/us-finland-economy-stubb-idUSKBN0MK2IO20150324">he suggests</a>, if politicians fail to curb taxes and government debt. <br />
<blockquote class="tr_bq">
The government debt of Finland has almost doubled since 2008, from 28 percent of gross domestic product to 48 percent at the end of 2014. Taxes have risen 3 percentage points over the same period as different administrations tried to preserve benefits without resorting to deep cuts. The jobless rate this year will rise slightly to over 9.1 percent, the government estimates. GDP languishes below its 2008 level - Bloomberg News.
</blockquote>
Certainly, having not adequately analyzed what was happening, the country has been running a series of fiscal deficits which continued beyond the crisis as the momentum provided by the housing boom has waned.<br />
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Naturally, with no growth and low inflation the government debt level has been rising rapidly.The level is still low - the IMF forecast it will hit the 60% of GDP EU limit this year - but if it continues rising at this rate it won't stay low for long.<br />
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Another hypothesis could be that of a balance sheet recession, but with government debt under 60% of GDP, and total private sector debt only around 100% GDP, this hardly seems plausible. Neither, for the same reason, does the idea that the country is simply trapped in a liquidity trap.<br />
<br />
So, what do you do about the problem of secular stagnation, if that is what it is? Again here there is divergence of opinion. Some still seek to treat the phenomenon as if it were a variant of the liquidity trap issue. Most notably Paul Krugman, who continues to hope that massive quantitative easing backed by strong fiscal stimulus will push economies like the Finnish one back onto a healthy path. But if the issue is secular stagnation, and the root is population ageing and shrinking, it is hard to see how this can be. The fact that Japan is just about to fall back into deflation 2 years after applying a monumental Quantitative Easing problem seems to endorse the idea that the problem may have no "solution" in the classical sense of the term. In <a href="http://krugman.blogs.nytimes.com/2014/04/09/stagnation-without-end-amen-wonkish/?_r=1">Stagnation Without End, Amen</a>, as if in response to this, Krugman contemplates the possibility that the natural rate of interest might be permanently negative, and concludes:<br />
<br />
"<i>I need to work a lot more on the mechanics of this paper; I’m wondering in particular whether there is a possibility of sustaining the economy with permanent fiscal expansion.</i>"<br />
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At first sight the idea of permanent stimulus seems weird, especially given the fact that it won't stimulate (in the normal sense) and also due to the longer term debt implications. But then, the possibility exists that secular stagnation is associated with constant deflation, in which case the central bank could print money for an extended period of time without causing inflation. I explore this possibility in my piece <a href="http://edwardhughtoo.blogspot.com.es/2015/02/eurogroup-money-for-nothing-and-your.html">EuroGroup - Money For Nothing And Your Debt For Free?</a><br />
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Leaving the Euro - which I think no one is suggesting - wouldn't be an advantage, since apart from losing the firepower of a large central bank for the debt scenario, the country would be unlikely to achieve meaningful devaluation. All the other Scandinavian countries are currently having to fight hard to avoid revaluation - largely due to being neighbours of the ECB - as I explain<a href="http://edwardhughtoo.blogspot.com.es/2015/03/does-arrival-of-negative-interest-rates.html"> in my post on negative interest rates</a>. The old debate about having monetary policy sovereignty is a bit out of date, especially at a time when even Janet Yellen is hesisitating to raise rates due to concerns about the currency impact of ECB action. How much more would a small open economy like Finland be at risk?<br />
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<b>Is There A Temporary "Free Lunch" </b><br />
<br />
Nothing ever comes entirely free, and one of the issues which arises with permanent QE is that it may be applied only at the cost of generating bubble type problems elsewhere, and issue which I look at in <a href="http://edwardhughtoo.blogspot.com.es/2014/06/secular-stagnation-part-ii-on-bubble.html">Secular Stagnation - On Bubble Business Bound</a>. But developed economies are in a bind, and they do need to find some path to move forward along.<br />
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Larry Summers - who was the first to use the expression secular stagnation in the current context - <a href="http://larrysummers.com/2015/02/25/reflections-on-secular-stagnation/#more-3942">advocates infrastructural spending to overcome the investment shortfall</a>, but I'm still not sure whether he recognises that this spending would need to become permanent, so we still end up with mounting debt. The Catalan economist Jordi Galí makes a similar proposal to the one Summers proposes, but again with a limited stimulus objective. However in one sense he does go farther. In "<a href="http://www.voxeu.org/article/effects-money-financed-fiscal-stimulus">Thinking the unthinkable: The effects of a money-financed fiscal stimulus</a>" he argues that the proposals he advances "<i>contrast with the experience with quantitative easing and other unconventional monetary policies, which do not affect aggregate demand directly and which, as a result, have failed to jumpstart the depressed economies of many countries, especially in the Eurozone.</i>"<br />
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He goes on to say, "<i>An additional advantage of a money-financed fiscal stimulus, particularly relevant for a monetary union, is that the associated increase in government purchases may be targeted at the regions with higher unemployment and lower inflation (or higher risk of persistent deflation).</i>"<br />
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At the end of the day, only two things can be said with a fair degree of certainty: short term fiscal austerity won't make any significant improvement to Finland's situation, and it could help make things worse (this whole discourse is based on a misunderstanding about what the problem is) while, on the other hand, what short term stimulus won't do is stimulate.<br />
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Structural reforms - aimed to increase labour market participation rates, and extend working lives - can help. So can measures to improve the quality of education, and the effectiveness of investment into new technologies. But if we look at Japan, even these offer no simple panacea. <br />
<br />
Finnish society, like many other European ones, is in the throes of a major transition. More debate needs to be held on what to do to facilitate the transition, and in the meantime deficit spending to make investments in future productivity improvements seems not to be a bad idea. Running deficits in order not to change, in contrast, would be.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-2463493670105194132015-03-17T11:10:00.000-07:002015-05-19T12:46:24.726-07:00When Will The ECB Start To Taper?What matters isn't what you think <b>should</b> happen, it's what <b>others</b> think <b>will</b> happen that counts.<br />
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Funny days these, the world seems to be constantly turning upside down. I could be talking about the arrival of negative interest rates in many European economies, but I'm not. What I have in mind is the crossover that seems to be taking place in the perceived fortunes of the US and the Euro Area economies. At the end of 2014 it was all "Europe bad, USA good" to the point that most observers were expecting an imminent rate rise from the Federal Reserve, even while the Euro was in such a bad state that ECB was being steadily pushed - kicking and screaming - towards a full blown programme of sovereign bond buying QE.<br />
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But now, only 3 months into 2015 everything is switching round, as investors become increasingly bullish of the <a href="http://news.yahoo.com/draghi-respite-nascent-upturn-complete-euro-185947505--finance.html">Euro Area recovery outlook</a>, even while <a href="https://www.businesscycle.com/ecri-news-events/news-details/economic-cycle-research-ecri-wli-rises">doubts on prospects for the US continue to mount</a>. To take just one example, US retail sales fell for the third successive months in February (whatever happened to the boost from lower gas prices?).<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhW4txHLpvwECJ_2RnoxN91nApp1ewVU9OWH3Wmufw-EPZoxnHVgl5eFFqkYULlm5zcZ8kD1gX-kxcyiLQ-VCKuRDdzdvy3YDfQAQ321y9wiC0Ewpu19Q_4hJwNzbH0X_S6vwLjwZuNokGS/s1600/2015-03-17_124921.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="195" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhW4txHLpvwECJ_2RnoxN91nApp1ewVU9OWH3Wmufw-EPZoxnHVgl5eFFqkYULlm5zcZ8kD1gX-kxcyiLQ-VCKuRDdzdvy3YDfQAQ321y9wiC0Ewpu19Q_4hJwNzbH0X_S6vwLjwZuNokGS/s1600/2015-03-17_124921.png" width="320" /></a></div>
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Indeed such has been the flow of negative data in the US that the Atlanta Fed GDPNow indicator has been steadily sliding downwards, with this weeks projection for Q1 2015 reading coming in at a measly annual 0.3%.<br />
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<span style="font-size: large;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhvPjp1QlxOro7wbyohHsTgwSe3hEvWYCVMq5IjnrEa3dxf2bRfgNZ-Rq7n1jL81c63302RIIFoElLOEUBb7iYbAhUPczDv9EJ6eKh6P8A6ZzwyAVlEdsqRB-r6itPjJ2QxkoL2gSFQgXl1/s1600/2015-03-17_171512.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="206" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhvPjp1QlxOro7wbyohHsTgwSe3hEvWYCVMq5IjnrEa3dxf2bRfgNZ-Rq7n1jL81c63302RIIFoElLOEUBb7iYbAhUPczDv9EJ6eKh6P8A6ZzwyAVlEdsqRB-r6itPjJ2QxkoL2gSFQgXl1/s1600/2015-03-17_171512.png" width="320" /></a></span></div>
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Well if the actual result is anything like this one, just get ready for all those Euroland overtakes US headlines.<br />
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<span style="font-size: large;"> Surprise, Surprise!</span><br />
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One of the most striking features of this turnaround is the way the the trend in the Citigroup Economic Surprise Indexes has inverted. These indicators measure economic surprises for the US, Europe, Japan etc. in terms of whether data exceeds or falls short of consensus expectations.
The Indexes weight selected economic indicators based on their influence on movements in the foreign exchange market on the day of their release. The standard deviation of the actual release from earlier economists' estimates are used to calculate the weights. The final indicator represents a three-month average of the raw daily figure. <br />
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Such indexes are quite useful as they give some sort of "soft" reading on whether economies are accelerating or decelerating at any given moment in time. If surprises are tending to the upside this means that (by-and-large) data is coming in better than the economists models forecast, and vice verse if the opposite is happening. Models base their expectations on historic data, but each moment in time is unique, so deviations from model predictions do have some meaning. And if these deviations follow a pattern, then they can give you a reading on the state of play of the business cycle.<br />
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Well, if we turn to the current trends in the US and Euro indexes, we get an interesting "surprise".<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhJhlTf_GIIqhoTsmF47OIRmJgyGLyyptFQr-VGVBz8cq1DD6xLVRcQisJs0M7nI8fctlZORZan4q1ABdS1nlSdsC_MpkH2Q1qXqkqODy9VEn-54myDX0hKCa0XKhSniyoaV-dt578wbxxK/s1600/2015-03-04_093927.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="198" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhJhlTf_GIIqhoTsmF47OIRmJgyGLyyptFQr-VGVBz8cq1DD6xLVRcQisJs0M7nI8fctlZORZan4q1ABdS1nlSdsC_MpkH2Q1qXqkqODy9VEn-54myDX0hKCa0XKhSniyoaV-dt578wbxxK/s1600/2015-03-04_093927.png" width="320" /></a></div>
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Euro-land is on a strong upswing, while the US economy is congenitally under-performing (relative to expectations). Meanwhile monetary policy divergence is accelerating, but in what appears to be the wrong direction. The Federal reserve is widely expected to raise US interest rates sometime in the next six months (although doubts are growing), while the ECB has just launched a version of QE which <a href="http://www.bloomberg.com/news/articles/2015-03-05/draghi-declares-victory-for-bond-buying-before-it-even-starts">seems to have achieved most of its objectives before it got started</a>. Eurozone bond yields are down, even negative, inflation expectations have started to rise, the Euro has devalued sharply, and now even <a href="http://news.yahoo.com/draghi-respite-nascent-upturn-complete-euro-185947505--finance.html">Mario Draghi is telling us</a> that "most indicators suggest a sustained recovery is taking hold."<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhmQ4aq9-VsCKrgg-btqfws3AxISiN1MzwGUs4lPug5LJ2zNUIiXxucIzLPCKojMGPmb0pGalkPh2WVdBmSMR7oLBV9okLnoGvpyTydnVQ4FPvVbhgYpTF5Q-UPU1uvjZ_qUcRS81_2mVSr/s1600/2015-03-17_135431.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="227" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhmQ4aq9-VsCKrgg-btqfws3AxISiN1MzwGUs4lPug5LJ2zNUIiXxucIzLPCKojMGPmb0pGalkPh2WVdBmSMR7oLBV9okLnoGvpyTydnVQ4FPvVbhgYpTF5Q-UPU1uvjZ_qUcRS81_2mVSr/s1600/2015-03-17_135431.png" width="320" /></a></div>
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(Movement in the Italian 10 year bond yield over last 3 years)</div>
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Euro Area inflation expectations have even started to rebound, even as their US equivalents keep falling.<br />
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<span style="font-size: large;"><b>So When Does The Taper Debate Begin?</b></span><br />
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In theory it is the intention of the ECB governing council to continue the 60 billion Euros a month bond purchase programme until September 2016, but as became clear in the Q and A session which followed the last meeting, this "intention" is in part data dependent. A point which has been forcefully hammered home in an interesting recent article from the FT's ECB correspondent Claire Jones -<a href="http://www.ft.com/intl/cms/s/0/a901fb54-c8ce-11e4-8617-00144feab7de.html#axzz3UZhKbXYe"> Euro plunge tests ECB inflation forecast</a>.<br />
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As Claire points out, "<i>The projections assumed that the exchange rate would stay where it was in the middle of February, about $1.13, until 2017. On Thursday (12 March), the single currency traded at $1.06. According to the ECB’s own estimates, a euro that weak would leave policy makers facing a headache about whether to scale down bond buying just months after unleashing their €1.1tn quantitative easing package.</i>"<br />
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In fact, she was very quick off the mark in picking this aspect up, since she had the following exchange with M Draghi during the press conference session:<br />
<br />
<b>Claire Jones (FT)</b>: What are the core inflation forecasts based on? Is it due to the bounce back in oil prices, or, now that you're more bullish on the economy does it reflect this?<br />
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<b>Mario Draghi</b>: Our monetary policy decisions have stopped a decline in inflation expectations that had started at the end of July last year.... It is true that, as you said, our projections of inflation are based on oil price futures, but also there are other factors, which play a role for core inflation. One is, of course, our monetary policy stance, and its effects on the exchange rate. The second one is the closing of the output gap, that we foresee happening gradually between now and 2017. <br />
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So straight out of the horses mouth, ECB monetary policy affects the exchange rate, and this affects the inflation outlook. So if, as many analysts are predicting, the Euro were to move towards parity with the USD in the coming months that would give an upside nudge to the bank's inflation expectations, and this would surely provoke a renewed debate on the ECB governing council about the desirability of proceeding as planned with the bond purchases. Remember, Mario Draghi didn't have a majority for proceeding with the programme as recently as December last year. As Claire says:<br />
<br />
"<i>The ECB has welcomed the euro’s depreciation, which should provide a much-needed boost to the eurozone’s exporters. But a sustained weakening could lead hawks on the governing council to ask some awkward questions about whether policy makers were right to keep on buying €60bn-worth of public and private sector bonds a month</i>.<i> </i><br />
<br />
<i>"With inflation forecast to reach 1.8 per cent by 2017 the ECB is heralding QE a success less than a week into its launch. However, under an alternative scenario outlined in the projections, a much weaker exchange rate would probably lead the ECB to miss its target, with inflation likely to rise above 2 per cent by the end of the forecast horizon. </i><br />
<br />
<i>The trouble is that the alternative scenario is already in danger of being realised.</i> <i>Under it, the euro is projected to dip to $1.04 by 2017. If the single currency continues to plunge at the pace it has done over the past five days then it would reach that level early next week.</i><br />
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The next batch of forecasts are not due till June, but already some of those who would favour earlier termination are out there testing the water. In fact Governing Council member Bostjan Jazbec, who represents Slovenia, was <a href="http://www.reuters.com/article/2015/02/05/us-ecb-jazbec-idUSKBN0L91U820150205">arguing it could end early one month before it started</a>. "<i>I understand it this way ...Once the price mandate is fulfilled, we can end it earlier,</i>" he told the Wall Street Journal on 5 February. <br />
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Marcel Fratzscher, who is not on the ECB board, but who - as Director of the DIW economic institute - has an influential voice in Germany, agrees. "The idea [in Germany] is that the ECB has been doing too much, and should really try to taper the programme rather sooner and before September 2016", <a href="http://www.bloomberg.com/news/videos/2015-03-16/german-greek-conflict-becoming-more-personal-fratzscher">he told Bloomberg TV on 16 March</a>.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1zHudt2Aw6VvM5Grmpg-5PI9bNNJpp1k7heLuit5G4UMz06-l2ab69d6U1HxOTvLPyT4UCQr84AJy8nzOx4iDg_v1RVoVSgDdC2DTYdkGMHg9v8HCiemOsEaa_go33rdzIrMydBEftZnX/s1600/2015-03-17_173759.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="172" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1zHudt2Aw6VvM5Grmpg-5PI9bNNJpp1k7heLuit5G4UMz06-l2ab69d6U1HxOTvLPyT4UCQr84AJy8nzOx4iDg_v1RVoVSgDdC2DTYdkGMHg9v8HCiemOsEaa_go33rdzIrMydBEftZnX/s1600/2015-03-17_173759.png" width="320" /></a></div>
<blockquote class="tr_bq">
"<i>Particularly in Germany the exchange rate is a big issue... the conflict over monetary policy will again intensify over the next couple of months.... The argument of Germany against QE was so far it will not be effective, now the complaint is maybe that it's too effective because it has been driving down 10 year yields in Germany to close to zero it has depreciated the Euro</i>."</blockquote>
A journalist for the Boston-based eFX News also <a href="http://www.investing.com/analysis/ecb-tapering-talk-precedes-qe-launch-243924">wrote in similar vein</a>. In an article entitled "ECB Tapering Talk Precedes QE Launch" we read:<br />
<blockquote class="tr_bq">
"<i>It may seem absurd to discuss the conclusion of QE before a single government bond has been purchased, but it's equally worth remembering that the controversial programme was pushed through the Governing Council against the expressed wishes of some heavyweight members, including Bundesbank President Jens Weidmann, who warned that improving economic data would negate the need to artificially suppress government bond yields and add to Eurosystem risks.</i>"<br />
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"<i>Should inflation begin its sustained rise towards the Bank's 'close to but below' 2% target next year in the wake of a modest economic recovery and a rebound in global crude prices, the myriad issues the Bank faces with its QE programme may give the Council enough reason to slow the pace of monthly purchases in order to demonstrate the "symmetrical" nature of its consumer price vigilance.</i>"</blockquote>
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<b><span style="font-size: large;">Low Entry Bar Makes QE Easier To End</span></b><br />
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The fact that Mario Draghi was able to convince his Governing Council to introduce QE on March 5 surprised many observers, who expected Germany to put up more resistance to the idea. In order to get it through the ECB the policy was explicitly tied to the mandate: maintaining price stability. This is the only meaningful objective of QE - not unemployment, not growth - and presented in this way (as Mr Draghi pointed out) not going ahead <b>would</b> have been illegal. <br />
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But, in this life, things that come easy are just as easily lost, so the low bar on entry will mean there is also a relatively low one for exit, and as Claire Jones suggests the tapering debate could start as early as June, especially with the Euro Area economies looking likely to outperform in the coming months.<br />
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The problem - as we are seeing in Japan <a href="http://www.bloomberg.com/news/articles/2015-03-17/kuroda-won-t-rule-out-cpi-dipping-below-zero-maintains-stimulus">where it looks like they are about to fall back into deflation again</a> - is getting a short uptick in inflation through currency devaluation is one thing, and solving a problem of deep structural deflation is another. If Europe's first brush with deflation is connected with its demography and declining working age population - <a href="http://edwardhughtoo.blogspot.com.es/2015/02/eurogroup-money-for-nothing-and-your.html">as I argue here</a> - then any tapering that does take place in the purchasing programme won't be the end of the matter, and the bank will probably be forced back into buying again soon enough. In addition Europe's present recovery is cyclical, but long term structural impediments to growth remain, so don't expect the wonders to last.<br />
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But one thing at a time: you will hear growing talk of ECB tapering as the months pass, and the only real unknown as far as I am concerned is how exactly periphery government bond markets will react to the news.
<b> </b><br />
<b>Postscript</b><br />
<br />
The above arguments are developed in much more detail in<b> the recently revised version </b>of my book "<a href="http://www.amazon.com/Euro-Crisis-Really-Over-whatever/dp/1502343436/ref=asap_bc?ie=UTF8"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/dp/B00NKA6PN8">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-43281372817417614482015-03-10T09:35:00.000-07:002015-05-19T12:45:56.084-07:00Why Is Spain's Population Loss An Economic Problem?<i>"Growth theory was invented to provide a systematic way to talk about and to compare equilibrium paths for the economy. In that task it succeeded reasonably well. In doing so, however, it failed to come to grips adequately with an equally important and interesting problem: the right way to deal with deviations from equilibrium growth……..if one looks at substantial more-than-quarterly departures from equilibrium growth……….. it is impossible to believe that the equilibrium growth path itself is unaffected by the short- to medium-run experience…….So a simultaneous analysis of trend and fluctuations really does involve an integration of long-run and short-run, or equilibrium and disequilibrium.</i> "<br />
Robert Solow, <a href="http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1987/solow-lecture.html" target="_blank">Nobel Acceptance Speech</a> <br />
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When the IMF said last year that Spain's unemployment level was unacceptably high, <a href="http://spaineconomy.blogspot.com.es/2014/07/spain-and-imf-round-bend-or-out-of-woods.html" target="_blank">I was pretty critical of the fact that they didn't spell out the consequences of this</a>, or <a href="http://spaineconomy.blogspot.com.es/2013/09/doing-nothing-is-not-option.html" target="_blank">offer any substantial policy alternative</a>. The most obvious impact of this failure to find an alternative is being seen right now, with the emergence of political movements which could well turn the country's two party system completely upside down, and the steady flow of talented young people out of the country in search of work.<br />
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According to the latest Metroscopia opinion poll carried out <a href="http://elpais.com/elpais/2015/03/07/media/1425753123_358981.html" target="_blank">for the newspaper El País</a> ( March 7 2015), four parties (Podemos 22.5%, PSOE 20.2%, PP 18.6%, Ciudadanos 18.4%) are in close competition for first place in the forthcoming election. The lastest arrival on the national political scene is Citizens (Ciudadanos), a movement which despite being difficult to pin down in terms of specific policy, seems to lie somewhere to the centre right, between PP and PSOE in terms of its political ideology. It is very hard to predict what the outcome of the coming general election (due at the end of this year) will be, but it seems clear that no one party will have a majority. So governmental arithmentic is about to get complicated.<br />
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The first indication of what the political landscape might start to look like should come in Andalusia, which has regional elections on March 22. Then in May there will be regional elections in Madrid and Valencia, and municipal ones in large cities like Madrid, Valencia and Barcelona. Such elections will, however, only give a vague impression, since personality factors and local loyalties will also be important.<br />
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As for the concerns which are driving this earthquake, these are clear enough from the opinion surveys: unemployment, corruption and the issues related to their current economic situation are by a long way the most important issues in voters minds, indeed despite all the talk of recovery the vast majority of them continue to think the current economic situation is either bad (41.8%), or very bad (33.8%).<br />
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Forthcoming alliances are hard to predict. Ideologically Podemos and Citizens may seem far apart, but the voter concerns which are driving their rise are often surprisingly similar, even if the solutions they offer are quite different. Over the corruption issue, for example, the possibility must exist of a de facto alliance between the two movements to force major reform on the two "traditional" parties.<br />
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Another issue which will probably unite them is that of debt. Many of Spain's citizens are badly indebted, and many still have difficulty paying their mortgages despite very low interest rates. In addition there is the notorious "full recourse" rule, which means people who can't pay can't simply return their home and liquidate their debt. There is a wide feeling of injustice associated with the fact that property developers received limited liability mortgages (many of which have now ended up with bad bank Sareb, with losses being met by taxpayers) while ordinary citizens were given no such "escape clause". "Rescue the citizens not just the banks," is a slogan you often hear these days.<br />
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It is unclear what Citizens propose to do about the issue, but Podemos's opinion is clear enough, and on this stance they enjoy widespread popular support, going well beyond those who will actually vote for them: they will revoke full recourse. It's not a mere detail that the point <a href="http://video.cnbc.com/gallery/?video=3000355396#." target="_blank">Pablo Isglesias stressed in his interview with CNBC's Michelle Caruso-Cabrera</a> was, "we can have governments that work for people and not for the banks," As the interviewer commented, "One thing he's really got going for him is ... that in Spain they can kick you out of the house and you still keep paying the mortgage. It's a recourse loan".<br />
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The other big issue is austerity. Spain still runs a large fiscal deficit - 5.6% of GDP in 2014 - the largest in the Euro Area. At first glance, with so many elections taking place it doesn't seem likely this will come down that much this year, and in 2016 it is hard to imagine there won't be a parliamentary majority in favour of prioritizing bringing down unemployment over reducing the deficit, making some sort of clash with the EU commission not improbable. Nevertheless, as long as ECB QE stays in place investors are hardly going to worry too much so yields wouldn't necessarily be affected. But what if the ECB wanted to taper?<br />
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<span style="font-size: large;"><b>The Price Of Doing Nothing</b></span><br />
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The social and political risks associated with Spain having conducted a far from complete economic adjustment are now becoming apparent, but there are also long term economic consequences, ones which may not be very evident at this point. People are often too busy celebrating a short term return to growth to ask themselves the tricky question of where all this is leading.<br />
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The most obvious result of having such a high level of unemployment over such a long period of time - Spain's overall rate won't be below 20% before 2017 at the earliest - is that people are steadily leaving the country in search of better opportunities elsewhere. Initially this new development was officially denied, and since there is little policy interest in the topic we still don't have any adequate measure of just how many young educated Spaniards are now working outside their home country. Anecdotal evidence, however, backs the idea that the number is large and the phenomenon widespread. All too often articles in the popular press are misleading simply because journalists have no better data to work from than anyone else. On the other hand work like <a href="http://www.iza.org/conference_files/mhc2013/jimeno_j141.pdf" target="_blank">this from researchers at the Bank of Spain</a> (Spain: From (massive) immigration to (vast) emigration? - 2013) only serves to illustrate how little we know, especially about movement among Spanish nationals.<br />
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On the other hand, when it comes to migration flows among non Spanish nationals we do have a lot better quality information due to the existence of the the municipal register electronic database. Everyone who wishes to be included in the health system needs to register with it (whether they are a regular or an irregular immigrant), and non Spanish nationals need to re-register with a certain frequency (so the authorities know if they leave). <br />
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More than an economic phenomenon, Spain's property boom was a demographic one. Since births only just exceeded deaths, between 1980 and 2000 Spain's population rose slowly, by just over 2 million people. Then between 2000 and 2009 it suddenly surged by 7 million. This was almost entirely due to immigration, with workers coming to the country from all over the globe attracted by the booming jobs market. Then in 2008 the boom came to an abrupt end, and unemployment went through the roof causing the trend to reverse. Since 2010 more people have left the country every year than have arrived, with the consequence that the population is now falling. Given that in 2015 the statistics office forecast that for the first time deaths will exceed births, it is most likely that this decline will continue and continue.<br />
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In fact the overall migration number - a net 251 thousand people emigrated in 2013 according to official data - only tells part of the story. The majority of young Spanish people working abroad are not included in these numbers (unless they have explicitly informed the Spanish authorities they are leaving, and few do this, partly because they do not consider themselves "emigrants"), but just as importantly the net balance masks very large movements in both directions. According to the national statistics office over half a million people (532 thousand to be precise) emigrated from Spain in 2013, while 285 thousand people entered the country as immigrants. So the net migration statistic covers over what are really very large flows.<br />
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The number of annual births in Spain has been steadily falling since the mid 1970s. They accelerated again slightly in the first years of this century, partly due to the shadow effect of an earlier boom in the 1970s, and partly because the incoming immigrants had a slightly higher birth rate. Coinciding with the outbreak of the crisis births peaked again in 2008 (after an initial peak in 1976 - ie 32 years later, average age at first childbirth is now just above 30) , and now the statistics office forecast a continuous decline.<br />
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The statistics office estimate there were just 2,280 more births than deaths in the first six months of 2014, which suggests that for 2015 as a whole the balance will probably be negative, as it will be in the years to come since the birthrate is around 1.35 children per woman of childbearing age. The drill-down effect means that since every generation is smaller, and there is only a replacement rate of about two thirds, the base of the population pyramid gets smaller and smaller over time.<br />
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The current data we have for Spain show the share of the population aged 65+ currently stands at 17% (or something over 7 million people, Instituto Nacional de Estadística-INE, 2008), of whom approximately 25% are aged over eighty. Furthermore, INE projections suggest the over-65s will make up more than 30% of the population by 2050 (almost 13 million people) and the number of over-eighties will exceed 4 million, thus representing more than 30% of the total 65+ population.<br />
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International studies have produced even more pessimistic estimates and the United Nations projects that Spain will be the world’s oldest country in 2050, with 40% of its population aged over 60. At the present time the oldest countries in Europe are Germany and Italy, but Spain is catching up fast.<br />
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In their most recent long term population projections the national statistics office suggested that Spain's population would fall to 41.6 million by 2052 (a 10% drop over current levels). While the number of over 80s rises sharply the number of people under 15 is forecast to fall to just over 5 million, a drop of about 25%.<br />
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But these long term projections only give an us an indication of what might happen given that there could be major changes in trend. Population movements are governed by two factors: the birth/death difference and by net migration. Since we are unlikely to see any substantial movement in the birth rate, migration becomes the critical variable. And what does migration depend on? Evidently the job market. This is why this issue is so important.<br />
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At present the rate of outward migration from Spain seems to be slowing as the economy starts to create jobs. But just how stable and sustainable is this trend? This is why the issue of whether or not Spain has taken enough measures to ensure a better longer term growth rate (a growth outlook which moves beyond picking the low lying fruit after the recession) becomes important. In the short term population projections published in November 2013 by the statistics office, Spain's population was forecast to fall by 2.6 million (5.6% of the present population) over the 2013-2023 decade. The largest population decline was expected to be in the 20 to 49 age group, which was expected to fall by 4.7 million (or 22.7%).<br />
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These are dramatic numbers, but it must be emphasized that they are very sensitive to emigration rates. For the moment the improving job market means the outflow numbers (while remaining large) are decreasing, although again it must be emphasized once more that we have very little knowledge about the actual migration rates of young educated Spanish citizens.<br />
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Whatever way you look at it this state of affairs is highly undesirable, and raises serious questions about the sustainability into the medium term of Spain's current economic recovery. If the level of unemployment is "unacceptably" high, this is partly because of the damage it will do to Spain's economic outlook in the longer term.<br />
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But won't they all come back? This is the answer I get time and time again. Such an outcome is far from guaranteed, even if it is what policymakers implicitly assume. As I am trying to suggest, whether those who are leaving come back or not depends on the state of the Spanish job market, and despite the fact jobs are now being created the size of the problem means the situation on the ground will remain difficult for many, many years to come. Some point to surveys, like the one shown in the chart below carried out by recruitment experts Hays, which show that a large majority of those leaving want to return. But wanting is not the same as being able. Few want to leave their home countries and their families to start a new life in a distant land, but many are now being forced to do so. Most initially don't see themselves as emigrants, but as time passes there is a growing possibility that that is exactly what they will become.<br />
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<span style="font-size: large;"><b>So What Are The Probable Economic Consequences of Doing Nothing?</b></span><br />
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What matters in Spain is not the fact that the economy is recovering. More important is how it is recovering, and how quickly the jobs market could get back to normal. Otherwise the risk exists that the longer run growth potential could fall even as the unemployment rate remains high.<br />
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It is a simple fact that as Spain's working age population falls so will the long term potential growth rate also fall. And if growth is lower, then new jobs will be less. As can be seen in the diagram below (which illustrates how EU Commission calculates potential growth rates). There are three inputs which matter a) the existing capital stock, b) labour force growth (which is a function of working age population), and productivity. <br />
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Now it is clear that as working age population turns negative (which basically happened in Spain around 2012) the dynamic also becomes negative for potential economic growth, and the only real hope of sustaining it in the longer term is via (total factor) productivity growth. But this - the "oh well, we'll raise productivity" argument - isn't as easy as it seems. The following chart which was <a href="http://blogs.ft.com/gavyndavies/2014/10/26/is-economic-growth-permanently-lower/" target="_blank">produced by Fulcrum research</a> based on Conference Board and IMF data and shows clearly how the trend towards lower productivity growth in developed economies is now decades long. It simply isn't credible to imagine that this trend is going to be turned around at the click of a finger.<br />
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So one of the obvious consequences of this population loss is a permanent fall in the long run trend growth rate. This situation is concealed at the moment as the very high unemployment rate means that in the short term an above trend rate of growth is possible, but this favorable situation won't last forever.<br />
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<span style="font-size: large;"><b>Housing Issues</b></span><br />
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The most obvious area of the economy to be affected by population decline is the housing sector. Spain has a very large stock of empty houses (well over a million, possibly two, between new and second hand), and the rate of home sales while rising is still very low.<br />
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During the boom years the fact that a very large "boom" cohort was in the household formation a group and then that a large number of immigrants arrived to set up their homes was a key factor in fueling the boom.<br />
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During 2007 474,000 new households were set up. In 2014 the equivalent figure was 117,000. Given this new dynamic it is very difficult to see how the outstanding stock of houses can be sold, how prices can recover, and how new building construction activity can take off again.<br />
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<span style="font-size: large;"><b>And Then, What Happens To Pensions?</b></span><br />
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Spain's pension system is on the rocks. Before the crisis it was running constant surpluses, but now the trend has reversed, and it is in constant deficit, and the shortfalls look set to stretch forwards as far as the eye can see. The curious detail about this situation is that even as the crisis deepens the government keeps raising the real value of pensions being paid. <br />
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On the other hand household consumption is surging: it was up an annual 3.9% in the last three months of 2014, a phenomenon which is leading many to talk of "<a href="http://edwardhughtoo.blogspot.com.es/2015/02/spains-good-deflation.html" target="_blank">good deflation</a>" in Spain. But what proponents of this argument tend to forget is that someone if paying for this "deflation boost" party. I the case of salaried workers the cost is carried by their employers, but in the case of pensioners the "fiesta" is being charged directly to the account of future generations of pensioners, as Spain's mini boom becomes increasingly consumption driven.<br />
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<span style="font-size: large;"><b><br /></b></span>
<span style="font-size: small;"><b> Shifting The Burden Onto The Reserve Fund</b></span><br />
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The fact that Spain's pension system was going to have problem maintaining the level of payments has long been known. In fact in recent years there have been two reforms which have tried to address different aspects of the problem. But it is really the huge loss of employment during the crisis that has really highlighted the chronic nature of the underfunding the system is being subjected to. Initially the then socialist government plugged the growing funding gap out of general government finances, but as financial markets started to focus on the size of the country's fiscal deficit this practice became increasingly problematic. <br />
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With the arrival of the PP there was a change in strategy and since 2012 the pensions deficit has been funded by drawing down on the Reserve Fund. This was established in 2000 and was meant to ensure the long term sustainability of the system, especially as demographic pressure mounted towards the end of this decade. The Fund had been accumulating the surpluses generated in the 2000 - 2007 boom years.<br />
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The financing switch has helped the headline fiscal deficit number, but the decline in the Reserve Fund that has been the result is starting to make a growing number of Spaniards increasingly nervous.<br />
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One part of the problem the system is having is simply the result of population ageing: the balance shifts as the number of pensioners rises and the number of contributors for each pensioner falls. Another part is the result of the recent economic crisis (since with so much unemployment less people contribute) while a third contributing factor are the recent changes in the labour market structure which mean that young people now earn a lot less than those retiring, leading average contributions to fall, while average pensions rise.<br />
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Some of the results of this sea change can be seen in the chart below (sorry about the Spanish, but I think the main points are easily grasped). The number of contributors for each pensioner hit a high of 2.71 in 2007, since then it has been falling and was at 2.25 in 2014. The number of pensioners has risen from 7.6 million in 2007 to 8.4 million in 2014. <br />
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The average pension paid is also rising. In February 2015 the total amount paid out by the system in pensions was up 3.1% year on year. But the number of pensioners was only up 1.3%, so the average pension went up by 2.1% due to the fact that the most recent retirees have been earning more than earlier cohorts and are thus entitled to higher pensions. We don't have data on this year's pension system income yet, but at the end of last year it was rising at about 1.5% a year, leaving a growing shortfall for the system to cover.<br />
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As I said, under the former PSOE the shortfall was funded out of the general government budget, and possibly 1.5 percentage points of the 9.6% 2011 fiscal deficit were the result of this financing. With the arrival of the PP in government this policy changed, and pension financing moved over to the Reserve Fund.<br />
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The attrition has been constant and the Fund is now starting to dwindle. In 2012 7 billion euros were withdrawn, in 2013 it was 11.6 billion euros and in 2014 15.3 billion euros (or 1.5% of GDP). If you want to compare apples with apples and pears with pears, you would need to add this 1.5% of GDP to the 5.6% fiscal deficit, giving a 7.1% deficit using the same accounting criteria as 2011. Put another way the deficit has really been reduced from 9.6% to 7.1% in 3 years, hardly dramatic austerity. Instead of paying the pensions gap out of current income the government are using a credit card issued by "future pensions" to keep payments up even though the situation is obviously getting worse, meaning it will be even more difficult to pay current pension levels in the future than it is now.<br />
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As a result of all these withdrawals the size of the Reserve Fund has fallen from its 66.8 billion euro peak in 2011 to the current level of 41.6 billion euros. At the moment the government have budgeted for another 8.4 billion euro withdrawal this year, but this number could easily turn out to be larger. So 2015 should close with around 30 billion euros outstanding - about 3 years more money at the current rate. It is clear that soon after the election changes will have to be made. Even though the number of contributors to the system is growing as the employment situation improves the rate of spending is rising faster.<br />
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There was a pension reform in 2013 which was intended to address the problem by making the system self financing. A complicated formula was introduced whose intention was to ensure that more money didn't go out - on a structural basis - than came in. But this was in the era when Spaniards still expected inflation as their economic default setting. As a result - and as a way of selling the reform - a minimum increase of 0.25% was set. Last December consumer prices were down 1.5% over a year earlier, and as a result the minimum rise was a generous "vote winning" increase of 1.75% at a time when the system itself was running at a huge loss. Something similar will happen this year, giving at least one part of the explanation as to why retail sales are doing better - in part these increased sales are being paid for with future pensions.<br />
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<span style="font-size: large;"><b>Madrid Fiddling While The Future Disappears Under Its Feet?</b></span><br />
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In principle, the fact that people are moving around looking farther afield for work is a good thing isn’t it? Simple economic theory suggests it should be. Indeed one of the habitual criticisms made by outside observers about the way in which the Euro currency union operated during the first decade of its existence concerned the absence of labour mobility within the region. Labour mobility as an adjustment mechanism in the face of economic shocks has been a leading topic in the economic literature on currency unions, both in the United States and in Europe. More than 50 years ago, in his seminal paper on optimum currency areas, Robert Mundell stressed the need for high labour and capital mobility as a shock absorber within a currency union: he even went so far as to argue that a high degree of factor mobility, especially labour mobility, is the defining characteristic of an optimum currency area – i.e. one that works well. Thus, a key question when evaluating whether the Eurozone is an optimal currency area has always been: how important is labour mobility as an adjustment mechanism in Europe compared with, say, the United States?
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So now that people are finally moving from one Euro Area country to another in search of work the currency union is working better, isn't it?<br />
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If only life were so simple. Two issues arise in the case of labour migration within the EU that make the situation different to that of movement from one US state to another. In the first place US states are inside one and the same country. This is important when we come to think about things like unemployment benefits, health systems and pension rights. In the second place US fertility still hovers round about population replacement level (2.1 total fertility rate). In most of the countries on the EU periphery fertility levels are significantly below 1.5 children per woman of childbearing age (Tfr), and have been for decades. <br />
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More recent evidence, however, suggests that things are now changing even there with 2011/2012 marking a turning point in migration patterns and population momentum all across the southern rim. The number of newly registered migrants into Germany from Italy and Spain, for example, rose by about 40% between the first half of 2012 and the first half of 2013. The number from Portugal rose by more than 25% over the same period and since then the process has accelerated. Numbers for London and Paris reveal a similar pattern.<br />
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Since unemployment in the Euro Area currently ranges from about 5% in Austria and Germany to over 25% in Greece and Spain there is plenty of potential for imbalance adjustment. Half-a-century after Mundell’s original article was published, the most ambitious attempt yet to create a single currency spanning a wide variety of national boundaries is about to see “optimal” labour mobility. But is it really so optimal? Is it as desirable as many assume to correct imbalances between countries through working age population flows rather than through devaluation? Is there any way to evaluate outcomes? Are there hidden costs in doing it in the former rather than the latter way?<br />
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As Nobel economist Robert Solow puts it in the quote with which I start this post, it is impossible to believe that the longer term path of an economy is unaffected by the trajectory taken during periods of deviation from trend - whether upwards or downwards. Emigration, and with it negative working age population dynamics, are being promoted by the ongoing labour market crisis in the worst affected countries. The question is just how far the longer term future of these countries is being put at risk by the form in which the adjustment is taking place. In allowing this to happen instead of addressing excessive indebtedness issues, are we simply replacing short term debt defaults with longer term pension and health system ones?<br />
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Young people are moving from the weak economies on the periphery to the comparatively stronger ones in the core, or even out of an ever older EU altogether. This has the simple consequence that the fiscal deficit issues in the core are reduced, while pressures on those on the periphery are only liable to get worse as welfare systems become ever less affordable. Meanwhile, more and more young people could follow the lead of Gerard Depardieu and look for somewhere where there isn't such a high fiscal burden, preferably where the elderly dependency ratio isn't shooting up so fast.<br />
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What impact are the migration trends within the Euro Area going to have on trend GDP growth and structural budget deficits in the respective member countries in the longer term? These questions are just not being asked.<br />
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As often happens in economic matters, solutions to one problem are inadvertently promoting the creation of another. Avoiding radical debt restructuring on the periphery, and going for a "slowly slowly" correction doesn’t necessarily mean that all other things remain equal. The Euro is being held together by allowing unemployment rates to adjust towards a narrower range via population flows.<br />
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The question is, is this good news? Obviously in one sense it is, if this is needed to make the Euro work it has to happen. But there is a downside: changes in the political process are lagging well behind developments in other areas, and especially in the migration one. It has been clear since the Euro debt crisis that a common treasury was a necessity for the good functioning of the currency union, that all participants would need to make sacrifices in this regard, yet progress towards this objective has been painfully slow, and full of bitter recrimination. At the end of the day the migration problem might just the issue that brings this simmering problem right to a head.
<b> </b><br />
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<b>Postscript</b><br />
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The above arguments are developed in much more detail in<b> the recently revised version </b>of my book "<a href="http://www.amazon.com/Euro-Crisis-Really-Over-whatever/dp/1502343436/ref=asap_bc?ie=UTF8"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/dp/B00NKA6PN8">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-45749775676502204962015-03-01T11:40:00.002-08:002015-05-19T12:46:59.220-07:00Does The Arrival Of Negative Interest Rates Change the Attractivess of Euro Membership?This is the second in a series of posts (<a href="http://edwardhughtoo.blogspot.com.es/2015/02/eurogroup-money-for-nothing-and-your.html">first one here</a>) in which I try to argue that the balance between costs and benefits of belonging to the European monetary union has shifted in the post crisis world, especially for heavily indebted countries such as those to be found on the European periphery.<br />
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The benefits of belonging (in terms of debt support given via ECB QE) have risen, while the disadvantages of being outside - as has been seen in countries like Denmark, Sweden and Switzerland - have also grown. This is not a complete cost/benefit balance sheet, but a limited exploration of just one area. That being said it is an area where exploration may help those who simply can't understand the recent determination shown by the Greeks to maintain their Euro membership, a determination which I think is difficult for those in London or the US (who are using a traditional deleveraging and monetary policy framework) to understand.<br />
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The key factor in tipping this balance has been the decision of the ECB to adopt a programme of sovereign bond purchasing QE. In <a href="http://edwardhughtoo.blogspot.com.es/2015/02/eurogroup-money-for-nothing-and-your.html">the previous post</a> I explained the situation as I see it about (existing and future additional) debt (low bond yields, free interest on debt purchased by central bank, etc).<br />
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The scenario I outlined is based on a number of simple assumptions.<br />
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i) That the long term movement towards lower interest rates is demographically driven.<br />
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ii) That an ongoing demographic transition offers the backdrop to the arrival of long term deflation in Japan and now a number of European countries. (See: <a href="http://uk.businessinsider.com/negative-interest-rates-being-driven-by-ageing-societies-2015-2">Negative Interest Rates Are Here To Stay, by Tomas Hirst</a>)<br />
iii) Since the problem is demographic central bank quantitative easing will not generate long term and sustainable inflation. (See Maasaki Shirakawa: <a href="https://www.bis.org/publ/bppdf/bispap77e.pdf">Is Inflation (or Deflation) "Always and Everywhere" a Monetary Phenomenon?</a><br />
iv) Given this central bank interest rates are likely to remain near to zero indefinitely and some form or other of QE is here to stay. Indeed, with interest rates increasingly stuck on the zero bond (<a href="http://www.bloomberg.com/news/articles/2015-02-27/central-banks-with-negative-rates-spur-question-of-how-low-to-go">is it still a bound any more?</a>) monetary policy is going to be all about how many non-standard measures you use, and currency levels and increasing function of how much, when compared with the other main players.<br />
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I would argue that my assumptions are both realistic and plausible, and of course have the advantage that they can be readily falsified, by the BoJ or the ECB being eventually able to "normalize" interest rates, for example. (On this see Larry Summers, "<a href="http://larrysummers.com/2015/02/25/reflections-on-secular-stagnation/#more-3942">will there room the next time we have a downturn for a 4% point decline in rates?</a>"). Such assumptions paint one possible scenario which is, if you like, my baseline case. This scenario may not be realized, but can economic and policy agents afford to ignore the possibility that it will? And if it does turn out to be confirmed by a rapidly changing reality, would this not change how we should think about Euro membership before recommending to countries like Greece to either stay or go?<br />
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Greece is a clear case of what I am talking about, since its current 175% of GDP government debt level has been reduced to a convenient "fiction" (with little in the way of real cost to the country) backed by the appropriate accounting framework which satisfies various national parliaments and confuses rather than enlightens the average layman. Further, if Greece eventually qualifies for ECB bond purchases then this "<a href="http://edwardhughtoo.blogspot.com.es/2015/02/eurogroup-money-for-nothing-and-your.html">debt for free</a>" component will only be consolidated.<br />
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So while Greece could exit the Euro and devalue, any benefits gained in terms of increased tourism would need to be offset against the fact that it would have to pay (probably at significant rates of interest) for at least some of its debt.<br />
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But here I do not wish to dwell further on this aspect of the situation, rather I'd like to look at the impact of having only a mid-size central bank at a time when a large neighbour (the ECB) is about to embark on a sizable QE programme. <br />
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<span style="font-size: large;"><b>The Arrival of Negative Interest Rates</b></span><br />
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The arrival of QE at the ECB is having substantial consequences all around the frontier of the monetary union. It is having identifiable impacts in countries as diverse as the UK (GBP hit a 7 year high against Euro this week), Switzerland, Denmark, Sweden, the Czech Republic and Poland.<br />
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While countries like Switzerland and the UK saw their currencies appreciate during the existential Euro crisis due to their "safe haven" status, what is happening now is a quite different phenomenon. In the first phase money was fleeing the currency union fearing conversion risk, now it is being <b>driven out</b> by an explicit policy of the central bank. At the very same moment Greece was being pushed near to the point of introducing capital controls to stop capital flight, Denmark <a href="http://www.bloomberg.com/news/articles/2015-02-23/banks-do-reality-check-on-report-of-capital-controls-in-denmark">was rumored to be near to introducing them</a> to stop capital inflows.<br />
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The build-up towards ECB QE is the essential backdrop to all this. The ECB is implementing a policy which is intended - however much the bank denies they target any given currency level - to make the Euro weaker, based on the idea that this should stimulate growth by encouraging exports, and raise inflation by making imports more expensive. This is the process we have seen at work in Japan. One of the main channels through which QE achieves this effect is via the so called portfolio effect. The central bank action (or even the promise of it) lowers yields on the bonds since they become virtually risk free and it is going to purchase, making them less attractive for investors. Faced with this, and with the fact that as the Euro weakens the USD value of such investments weakens, the hope is investors offload the bonds they have in their portfolio to the ECB and put the money freed up to use elsewhere. In fact the bank <a href="http://www.forbes.com/sites/jonhartley/2014/10/02/the-consequences-of-draghi-and-the-ecb-setting-negative-nominal-interest-rates-in-europe/">even introduced a negative deposit rate</a> for those commercial banks storing money in its vaults to try to induce this effect.<br />
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In principle it is hoped that the additional liquidity generated ends up financing lending in the struggling economies of the Euro Area, but in practice it is more likely the funds move offshore (at least while the Euro is trending down), in the process weakening the Euro. The challenge for investors under these circumstances is to find currencies whose value is likely to rise as the Euro falls: enter the Swiss Franc and the Swedish and Danish Crowns.<br />
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<span style="font-size: large;"><b>The Swiss Cap</b></span><br />
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The Swiss National Bank hit the headlines in January when it unexpectedly removed the 120 cap on the Swiss Franc exchange rate with the Euro, a policy measure which has been kept in place over more than three and a half years. Within minutes of the announcement the CHF surged, and was up by 30% at one point during the day, although it did eventually settle down at a level of 0.98 to the Euro, a rise of nearly 20%.<br />
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At the same time the SNB lowered the deposit rate rate from -0.25% to 0.75% taking it deeper into negative territory. The decision caused havoc in financial markets and was widely criticized for its abruptness, although it is hard to see how, once you have such a measure in place, you can remove it other than abruptly. The move hit those who had been foolhardy enough to borrow in Swiss Francs hard, and will probably hit Swiss exporters even harder over time, but given the relative sizes of the two central banks the country had little alternative. Now Switzerland will import some of the deflation the Euro Area wants to export.<br />
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Swiss bond yields soon followed the deposit rates into negative territory.<br />
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And it wasn't only the 10 yr bond, those of shorter duration went to ever lower levels. On the 22 January the 1 year bond yield hit -1.38%.<br />
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Negative rates have even started to reach corporate bonds, raising the possibility that companies could eventually be paid to borrow the money to proceed with share buy-backs.On 3 February <a href="http://www.ft.com/intl/fastft/272032/nestle-bond-yield-falls-below-zero-on-bond-frenzy">a 20 month Nestle bond</a> started trading below 0%.<br />
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<span style="font-size: large;"><b>Then Came The Danish Peg</b></span><br />
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Seeing the havoc - and trading opportunities - that were created in markets by the Swiss Cap removal investors did not need much convincing to put themselves to work looking for other possible "volatility" candidates, and it didn't take them long to stumble upon the Danish Krona's peg with the Euro.<br />
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Voters in Denmark rejected Euro membership in a referendum at the start of the century. As a consequence the Danish krone now forms part of the ERM-II mechanism, with an exchange rate which is tied to a band of plus or minus 2.25% around a rate of 7.46038 to the Euro. The question is, are the Danes enjoying this situation? Would they like, as many in London assume, to move to a free floating currency? Looking at the determination of the Danish central bank to resist the pressure of those who would break the peg, the answer seems to be no. The Danes, and especially their important export industries are anxious not to follow along the Swiss path. Yet the cost of trying not to do this is not negligible.<br />
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In the first place, and despite having an already over-leveraged household sector, <a href="http://www.bloomberg.com/news/articles/2015-02-05/mortgage-banks-to-meet-with-danish-government-on-negative-rates">you can get paid</a> in Denmark to take out a mortgage (<a href="http://www.dr.dk/Nyheder/Penge/2015/01/30/0130122132.htm">and here</a>, in Danish). Danish households owe their creditors 321% of disposable incomes, according to the Organization for Economic Cooperation and Development. "That’s the highest ratio in the world and a level that’s prompted warnings from both the OECD and the International Monetary Fund to rein in borrowing. Danish authorities have argued that households aren’t at risk thanks to high pension and household equity levels",<a href="http://www.bloomberg.com/news/articles/2014-01-06/world-s-highest-household-debt-burden-probed-by-danish-council"> according to Bloomberg</a>. Meanwhile, even years after Denmark’s property bubble burst, house prices in the country’s biggest cities <a href="http://www.bloomberg.com/news/articles/2015-02-19/extreme-negative-rates-feed-danish-housing-boom-in-currency-war">are already higher than at any point in recorded history</a>. <br />
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The backdrop to the situation has been the Danmarks Nationalbank's <a href="http://www.ft.com/intl/cms/s/0/d3c385f6-adc6-11e4-919e-00144feab7de.html#axzz3T814TIS7">constant lowering of the deposit rate</a> (3 times in three weeks) to a current global record low of minus 0.75%. “<i>The main message is that we are ready to do whatever it takes to defend the peg,</i>" central bank governor Lars Rohde told the Financial Times, "<i>We have unlimited access to Danish krone and we have no restrictions on our balance sheet.</i>”
Asked how low rates could go, Mr Rohde replied: “<i>We have to admit that we are in unmapped, uncharted territory. Of course, we are well aware there are negative impacts on the financial industry of negative interest rates. But our priority is simply to defend the peg and we will do what it takes</i>.”<br />
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Another unusual result of the policy is that commercial banks are now starting to charge retail customers <a href="http://www.wsj.com/articles/danish-lenders-take-unprecedented-steps-to-combat-negative-interest-rates-1423576590">negative interest on their deposits</a>. In times of negative lending rates "paying our customers zero or positive interest is very bad for profitability", Palle Nordahl, FIH Erhvervsbanks chief financial officer, told the Wall Street Journal. Denmark is itself experiencing very strong disinflation and the central bank is clearly concerned lest this becomes outright deflation, yet breaking the peg and floating would see the currency pushed up, not down as the country needs.<br />
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<span style="font-size: large;"><b>And Finally Sweden Sprints For The Bottom</b></span><br />
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On 11 February the Riksbank, the very selfsame one that Paul Krugman had <a href="http://krugman.blogs.nytimes.com/2014/07/05/swedish-sadomonetarist-setback/">referred to as "sado-monetarist"</a> for its 2010/11 rate hikes, surprised everyone by <a href="http://www.nytimes.com/2015/02/13/business/international/sweden-cuts-interest-rate-and-announces-bond-buying-program.html?_r=3">announcing it was cutting its benchmark rate to minus 0.1%</a>. At the same time the bank announced a QE style programme of bond purchases. In fact, those looking at what had been happening in Switzerland and Denmark should not have been so surprised: bets the country's currency would rise had been increasing at the same time as the country was sinking steadily into deflation. No other central bank has maintained a negative deposit rate as low as the Riksbank has. The bank reduced the rate for commercial banks to -0.85% in Feb after having maintained it at -0.75% since October 2014, just to keep one step ahead of the Danes.<br />
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In fact the central bank's monetary policy had been geared to steadily weakening the currency over the last two years, and <a href="http://www.bloomberg.com/news/articles/2015-02-26/riksbank-minutes-reveal-krona-happy-policy-makers">Bloomberg have the currency down as the worst performer</a> among nine major currencies, with a drop of some 12% over the last 12 months. Naturally all this was being put in jeopardy by the arrival of the big ECB neighbour onto the quantitative easing terrain. As central bank governor Stefan Ingves <a href="http://www.nytimes.com/2015/02/13/business/international/sweden-cuts-interest-rate-and-announces-bond-buying-program.html?_r=3">put i</a>t: “<i>It’s like sailing in a small boat on a big ocean.That’s reality when you come from a midsize fairly open economy.</i>”<br />
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What makes the Swedish case such an striking one is that the economy<a href="http://www.nasdaq.com/article/swedens-gdp-grew-11-percent-in-the-fourth-quarter-2014-20150227-00075"> is growing quite rapidly</a> - it was up 1.1% q-o-q in Q4 2014, and by 2.7% y-o-y - and the housing market is booming. Credit growth was an annual 6.1% in December, while house prices in January were up 9% over a year earlier. And Sweden comes second only to Denmark in an international comparison, with <a href="http://www.marketmoving.info/swedish-housing-market-bubble-poses-huge-risks/">mortgage debt running at around 80% of GDP</a>. Yet such is the fear of what the backdraft from ECB might be that policymakers felt they had little choice but to go for what they clearly see as the "lesser evil".<br />
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<span style="font-size: large;"><b>Global Financial Accelerator</b></span><br />
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I think it is now reasonably obvious to all concerned that having a single size monetary policy that did not make allowance for the specific needs of individual countries played a significant part in blowing credit bubbles and facilitating competitiveness-loss on Europe’s periphery. So far so good. But having noted this, it’s worth remembering that the world we live in today is not identical to the world of the early 1990s when the essentials of the Euro architecture were first thrashed out.<br />
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In particular financial globalisation and mass migration flows have significantly changed the environment in which monetary policy operates. One of the first to draw attention to the way things were changing was the Danish economist Carsten Valgreen <a href="http://books.google.es/books/about/The_Global_Financial_Accelerator_and_the.html?hl=es&id=O-guMQAACAAJ">who coined the expression Global Financial Accelerator</a> in the pre-crisis years to describe one of the most important of the new phenomena. Simply put normal standard interest rate policy had been weakened by the growth of non-linear currency effects. This point has still not gotten home to many policymakers, a reality which was underscored by a <a href="http://www.bloomberg.com/news/articles/2015-03-01/speculator-mania-for-danish-krone-hard-to-understand-oecd-says">recent interview given by the OECD's chief economist, Catherine Mann</a>. “<i>It’s actually strange that there’s such a pressure for appreciation,</i>” she told Bloomberg's Peter Levring when asked about what was happening to the Danish Krona.<br />
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“<i>The economy isn’t that strong, it’s not very different from the euro area, so demand for appreciation shouldn’t be that strong</i>,” she went on to say. It shouldn't be, but it is, and this is hard to understand using conventional models, although as we have seen it is perfectly comprehensible and even predictable. It's the forex factor that dominates yields, and if the peg breaks and the Krona spikes upwards as the Swiss Franc did there is plenty of money to be made by holding Krona denominated assets. Since the ECB is a lot bigger and a lot stronger there is little downside risk, and in addition Denmark is rated Triple A.<br />
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In fact, Allianz SE's chief economic Mohamed El-Erian clearly gets the key point in<a href="http://www.bloombergview.com/articles/2015-02-27/mohamed-el-erian-10-facts-about-negative-bond-yields?hootPostID=ec3e3f3fd9ca409e999f2a23c7070b08"> his recent Bloomberg View article</a>: investors aren't driven by yield, but by the <b>possibility of capital gains</b> if yields are driven even deeper into negative territory.<br />
<blockquote class="tr_bq">
<i>"The seemingly illogical willingness of investors to pay issuers to borrow their money is neither irrational nor driven by just noncommercial considerations (such as regulatory requirements or forced risk aversion). As the European Central Bank prepares to start its own large-scale purchasing program next week, some investors believe they could make capital gains on such negative yielding investments."</i></blockquote>
And this situation is not new. Already in the early years of this century Valgreen was drawing attention to just how powerless national monetary policy had actually become, especially in small open economies, in a world of fluid cross-border financial flows. The thought involved is really quite straight forward: real economic
decision makers are increasingly insulated from local monetary
conditions and more sensitive to global ones and transnational credit
extension willingness (or, if you prefer, global risk sentiment). In order to illustrate his point he selected two countries – Iceland and Latvia - both of which were later to gain a certain degree of notoriety. As it turned out neither the Icelandic nor the Latvian central bank were able, using simple recourse to conventional monetary policy tools, to control the rate of credit extension in their countries. The end result in each case was surprisingly similar, despite the fact one had a free floating currency and the other was on a peg.<br />
<br />
The Icelandic central bank could control the interest rate on Icelandic Krona. But that did not matter much for households, non-financial companies or banks borrowing funds in foreign currency. As Valgreen argued in the Icelandic case, as long as the banks maintained a high credit rating and were perceived as sound by the international markets, credit flows easily to them in a liquid global environment. “Perversely”, he noted, “it even seems as if a stronger currency stimulated the Icelandic economy in the short run, as consumer spending reacts to increasing external buying power and as exports are concentrated in price insensitive commodity sectors.”<br />
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What seems to matter more than ever before is global liquidity, and global risk sentiment as can be readily seen at the present time in the growing market for European periphery government bonds. <br />
<br />
While Valgreen was probably the first to identify this “perverse” rising-currency stimulating credit-growth (financial accelerator) phenomenon, it was later to gain much more attention following Ben Bernanke’s various attempts to put the pedal to the metal on US credit demand via systematic quantitative easing. His policy was most successful, not as he had intended in the United States, but in countries as far apart as Thailand, India and Brazil. Reserve Bank of India governor Raghuram Rajan's revealed his frustration when he <a href="http://www.moneylife.in/article/raghuram-rajans-tough-battle-against-bubbles/34956.html">went to Frankfurt last year and complained to his audience</a>: "We seem to be in a situation where we are doomed to inflate bubbles elsewhere."<br />
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Thus the world of international macroeconomics has changed mightily over the last decade, and things are far from being what they used to be. Which should give us all some serious food for thought when it comes to arguing in favour of a simple return to the status quo ante in the case of the Euro Area countries.It should also help those living outside the Euro Area who to understand the strong desire shown by voters in Greece and elsewhere to stay in EMU despite all the evident disadvantages. On a worst case scenario Greece could become another Serbia, an outcome few either in Greece or outside would wish on the country, but on the best case one it would become a Denmark or a Sweden, with its monetary policy and its currency value essentially determined elsewhere. They would most definitely not be getting the ability to determine their own future since the days when international capital movements were characterized by simple models like <a href="http://web.mit.edu/krugman/www/triangle.html">Krugman's eternal triangle</a> are now long gone.<br />
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<b>Postscript</b><br />
<br />
The above arguments are developed in much more detail in<b> the recently revised version </b>of my book "<a href="http://www.amazon.com/Euro-Crisis-Really-Over-whatever/dp/1502343436/ref=asap_bc?ie=UTF8"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/dp/B00NKA6PN8">including Kindle</a> - at Amazon.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBQQdNRTkPuVgM7aXN1u9dq7LP9r2Ylzt9pH3015lJ2LukpOSDvliKZq6kz4ggV-zkoAYshyphenhyphenbeYL5IowPi5KQ5QPh0tjAESZDl_r9oN4TMRzmifVvf7nZO_0n7FIqjDj-K1Jtv3RrCBmfw/s1600/2014-09-13_183508.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="320" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBQQdNRTkPuVgM7aXN1u9dq7LP9r2Ylzt9pH3015lJ2LukpOSDvliKZq6kz4ggV-zkoAYshyphenhyphenbeYL5IowPi5KQ5QPh0tjAESZDl_r9oN4TMRzmifVvf7nZO_0n7FIqjDj-K1Jtv3RrCBmfw/s1600/2014-09-13_183508.png" width="214" /></a></div>
<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-18028033562867986182015-02-24T10:50:00.002-08:002015-05-19T12:48:28.595-07:00EuroGroup - Money For Nothing And Your Debt For Free?There's an interesting question about "analysis" which confronts anyone who seriously wants to engage in it: do you organize your focus around what you <b>want to happen</b> (practical policy emphasis) or do you concentrate your efforts in detailing and outlining what you <b>think will happen</b>? Naturally the closer you are to having an ideological discourse the harder this distinction is to either see or maintain. But even for "non ideological" thinking the issue is far from being an easy one. Whether or not there is any such thing as "objectivity" is a complex philosophical question and attempts to achieve it fraught with all manner of difficulty, but surely we at least have to try? <br />
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I raise this point, because while those who write what is called "sell side" analysis do no more (and no less) than the name suggests - no one would really think such work was either objective or independent - we shouldn't abandon too easily the objective as being unattainable.<br />
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The issue becomes even more complex when you consider just how major multilateral institutions like the EU Commission and the IMF have steadily shifted their role since the start of the financial crisis, away from independent criticism and towards "talking up" troubled economies who are under their guidance. I think Larry Summers presented this issue nicely <a href="http://larrysummers.com/imf-fourteenth-annual-research-conference-in-honor-of-stanley-fischer/">in his IMF research conference speech</a> when he said: <br />
<blockquote class="tr_bq">
<i>"I agree with the vast majority of what has just been said [by Ben Bernanke, Stan Fischer and Ken Rogoff] – the importance of moving rapidly; the importance of providing liquidity decisively; the importance of not allowing financial problems to languish; the importance of erecting sound and comprehensive frameworks to prevent future crises. Were I a member of the official sector, I would discourse at some length on each of those themes in a sound way, or in what I would hope would be a sound way. But, <b>I’m not part of the official sector, so I’m not going to talk about any of that</b>." </i></blockquote>
Ever since Robert Lucas shifted attention in economic theory towards the role played by expectations, the artist has somehow been painted into the very picture he or she is painting. You can't talk about a topic without in some way changing the understanding (expectations about) the phenomenon in question. If you write, for example, that the Euro Area is stuck in deflation, doesn't that somehow add to the expectation that it may be? <br />
<br />
But there is another issue, and it's not simply about objectivity or bias, it's about communication, and about what others are prepared (or able) to think about (contemplate) at any particular point in time. I had my own personal problem with this just last week, when I wrote <a href="http://spaineconomy.blogspot.com.es/2015/02/spains-good-deflation.html">a lengthy post</a> on the so called "good deflation" phenomenon in Spain. I personally think - for reasons which will emerge below - that contemporary deflation is substantially different from the depression-related deflation we saw in the United States in the 1930's, the phenomenon around which much of modern economic theory on the topic cut its teeth. There is a very big difference between a 1% fall in prices every year for 15 years (the Japan experience) and a 15% fall in one year. Modern deflation seems <a href="http://krugman.blogs.nytimes.com/2014/05/19/demography-and-the-bicycle-effect/?_php=true&_type=blogs&_php=true&_type=blogs&module=BlogPost-Title&version=Blog%20Main&contentCollection=Opinion&actio&_r=1">more related to a structural weakness in domestic demand and investment</a> associated with shifting demographic dynamics than it is to ongoing <a href="http://en.wikipedia.org/wiki/Debt_deflation">debt deflation</a>, although many would be inclined to deny this.<br />
<br />
But is the tendency towards denial based on intensive empirical study of the modern deflation phenomenon, or is it driven by the fact that if the problem is largely demographic then it has no evident solution. This is how the need to do policy can frame analysis, since the objective (sound policy) governs the analysis, indirectly making the practitioner more inclined toward one hypothesis rather than another.<br />
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I personally hold the opinion that modern deflation largely has demographic roots, and basically think policy should come to be about learning to live it, and about how to manage our economies in such a context, rather than continually attempting to escape (Abenomics) from a phenomenon from which there is - in all probability - no escape. That is the approach which characterizes my work on Japan.<br />
<br />
But in Spain the debate is at a different point. Whereas in Japan there is a live and ongoing discussion about whether the country should be doing Abenomics or not, the majority of policymakers and sell-side people in Spain have not reached this point. They are still essentially arguing either that i) the country isn't in deflation, or ii) even if it is, Spain's deflation is of the "good" kind. As a result I ended up writing a piece which argues that Spain is in deflation (and has been for longer than most people imagine) and which explains that - as <a href="https://twitter.com/TobiasBuckFT/status/567651852809158656">Tobias Buck described it in his tweet on the piece</a> - "There is nothing good about deflation in Spain".<br />
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But if there's nothing "good" about the phenomenon, you might imagine I was suggesting doing something about it, like implementing QE at the ECB, for example. Well basically, if you thought that you would be wrong. I think there is nothing good about Spain's deflation, but that this is what there is. Not a perfect world, and it isn't my objective at this point to go into why people so often seem to imagine it could be. But naturally, if something is "bad" then from a policy perspective you should be looking for a solution, and the solution that's up and coming on the current agenda would be ECB QE. And if you think certain kinds of policy outcomes are likely then it becomes interesting to ask what the world will look like if the policy is implemented, even if you personally don't believe in its efficacy in terms of declared objectives, and this is what I am trying to do in this post.<br />
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What I want to look at are the implications of having ongoing deflation and increasing QE at the ECB (both of these contingent but empirically verifiable conditions) for the balance of calculation about whether or not a given country is better off staying in the Eurozone or leaving it. In other words, its a kind of thought experiment based on plausible assumptions: that deflation is demographically driven and that the ECB will continue to implement QE (or QQE) in a (forlorn) attempt to bring it to a halt. I think this kind of line of thought is worth pursuing since it will give us some idea of the kind of world we may be living in 10 years hence and move us on a bit from scrutinizing every piece of communication to determine whether the list of reforms proposed by the Greek government will be acceptable to the German one. Or whether the Greek government will have to meet its short term financing needs by issuing T-bills, or will the ECB will agree to advance the 1.9 billion Euros interest rebate which is pending? Sometimes we need to look beyond the end of our noses.<br />
<span style="font-size: large;"><b><br /></b></span>
<span style="font-size: large;"><b>What Greece Needs Is It's Own Currency?</b></span><br />
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Judging by what runs through <a href="https://twitter.com/Edward_hugh">my Twitter feed</a>, I can't help getting the impression that most London based investors still have a line on debt, currencies and interest rate policy which hasn't evolved that much since the 1990s. The over-riding assumption is the Euro is overvalued for Greece's needs, that having your own currency and being able to implement your "own" monetary policy carry strong benefits, ones which far outweigh - for example - losing the anchor which is provided by an EU promoted structural reforms programme.<br />
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That the Euro was set up with major - almost fatal - institutional deficiencies is obvious, possibly now to everyone. Ditto for the fact that for many of the countries who participated in the experiment the balance of the first decade is in all probability negative. Ditto that the single size monetary policy was manifestly applied counter to the interests of a number of economies on the periphery, economies which subsequently got into a great deal of difficulty.<br />
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But the question that really is crying out to be asked is: "has anything relevant changed"? Is there no difference between the world of 1995 and that of 2015? I personally think there is, and that the changes that have occurred can alter how we think about the whole question of Euro Area membership. Possibly to the extent of being able to understand why it is very much not in the interest of the Greeks to exit the currency at this point.<br />
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There are a number of features of our current economic and financial environment which make the world a very different place now to the one we used to live in back in the 1990s. These would be: i) the rise of financial globalization, ii) the arrival of deflation in a number of developed economies and iii) the limitations placed on standard interest rate policy by the existence of the Zero Bound and the rise of non-standard measures, in particular QE.<br />
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There is a fourth and separate point - the existence of accumulated sunk costs - which also enter into any calculation about the difference between deciding to join and deciding to leave, but this one has been widely covered in earlier debates about Grexit, so can be treated to some extent as "shared knowledge". <br />
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<span style="font-size: large;"><b>QE at the ECB</b></span><br />
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January's decision by the Governing Council of the ECB to initiate a series of sovereign bond purchases as part of more general programme of quantitative easing, is historic and its significance goes well beyond immediate deflation concerns. The modality of the programme is more or less as follows:<br />
<br />
i) there will be 50 billion Euros in sovereign purchases every month from March 2015 to September 2016 plus 10 billion Euros more under the existing asset backed securities and covered bond programme.<br />
ii) purchases will be from the secondary not primary market (something the European Court of Justice opinion highlighted as important in any ECB programme).<br />
iii) 12% of the 50 billion Euro monthly purchases will be of EU and EU institution securities.<br />
iv) the purchasing will be done by the national central banks and will be in proportion to the capital key share of each country.<br />
v) only 20% of the additional asset purchases will be subject to risk sharing.<br />
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This is a large programme, which will produce an increase of around a trillion Euros in the ECB balance sheet. The decision to warehouse 80% of the additional purchases at the national central banks has attracted a lot of attention, since it is clear that this procedure falls well short of full financial integration. The other side of the coin, though, is that it makes the cost of leaving the Euro much higher, since the part of the debt which will be held at the national central bank will effectively be virtually interest free as long as the country is in the Eurosystem (see below) whilst outside the Eurosystem framework such a programme would almost certainly be impossible to implement, and market based interest rates would be above current ones. <br />
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If you are a country with no debt, then maybe life outside the Euro would be beneficial (maybe, there are other considerations), but if you have legacy debts (even restructured ones) then in the context of evolving QE (and there is a long, long way that the ECB can go with this over time) it can only be more expensive for you to find yourself outside. This is so whether you are looking at things from a purely debt sustainability point of view, or from an indebtedness as a drag on growth one. What makes the difference? The arrival of deflation is what makes the difference, since it is this that enables a central bank with deep pockets to increase its balance sheet almost indefinitely with generating inflation. And it is this deflation aspect which makes ECB QE so different from that practiced in the UK or the US, and so similar to what is going on in Japan.<br />
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<span style="font-size: large;"><b>Long Term Disinflationary Trend</b></span><br />
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Many argue that the current deflation in Europe is simply the result of a short term energy price shock, but as this chart presented by Larry Summers illustrates in support of his secular stagnation hypothesis illustrates the trend towards negative rates has been a long lasting one.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjKF8pdSQkom5A-lqqRMet5Gp-we4aW0serD_rdfGhHK2-E1HIbYRVyqFcJ2b3NS6hcsx4WFe0yELShVP16siwocmj1dchU7IPwaV0rKuPGlHNOIrodja0pPtl3TdslX9hifnmnJBXb5IJb/s1600/2015-02-10_124739.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="201" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjKF8pdSQkom5A-lqqRMet5Gp-we4aW0serD_rdfGhHK2-E1HIbYRVyqFcJ2b3NS6hcsx4WFe0yELShVP16siwocmj1dchU7IPwaV0rKuPGlHNOIrodja0pPtl3TdslX9hifnmnJBXb5IJb/s1600/2015-02-10_124739.png" width="320" /></a></div>
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As has the trend towards lower (and eventually negative) government bond yields. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEje9_bd006-9dxBeJIq1BnTTEkh04z9Cmk5r6B9i5MwhTjUyqxCIMparnaYNJS-tU6jpWQOd7G7tZ8x8na_h5qUW9PXdy0uj9oT6DoCR0l4nX8PfAKbr-Xb16KWL3HwscKa3qY6n_8bnRpB/s1600/2015-02-10_124418.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="225" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEje9_bd006-9dxBeJIq1BnTTEkh04z9Cmk5r6B9i5MwhTjUyqxCIMparnaYNJS-tU6jpWQOd7G7tZ8x8na_h5qUW9PXdy0uj9oT6DoCR0l4nX8PfAKbr-Xb16KWL3HwscKa3qY6n_8bnRpB/s1600/2015-02-10_124418.png" width="320" /></a></div>
And inflation in many developed countries has been on a secular downward trend running across decades, as this Swiss CPI chart shows.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhglIQfbPUZDwsPtED4StlSzRLu-e3QmF9DVLFQQ_moyz4oMm7Bg6QYC9b3l_qWvMsNxoPaIJ9jjKSW96Rg0SsedwJVlkkK1UfLlUIM9bWn8x-ZUww4NMULjaC_bvsGbUrChF8uIWdCiQJA/s1600/2015-02-24_153349.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="192" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhglIQfbPUZDwsPtED4StlSzRLu-e3QmF9DVLFQQ_moyz4oMm7Bg6QYC9b3l_qWvMsNxoPaIJ9jjKSW96Rg0SsedwJVlkkK1UfLlUIM9bWn8x-ZUww4NMULjaC_bvsGbUrChF8uIWdCiQJA/s1600/2015-02-24_153349.png" width="320" /></a></div>
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So something is happening, and that something evidently isn't simply transitory and energy related. Here's Spanish consumer inflation with the energy component stripped out.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhiOBOZ3TDAf8HOMoFUf1a0SksrhB7JYkXT2aMb-ft4o9W3MDJzcKLuIoOTiD3XkNGoUyvCOI3WHsWczmd7WHROdh7ayfzp62mAxtuAV6yUOUHXP1n1462QrzW8dA-sP75SWegU08VoEGKn/s1600/2015-02-20_122151.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="167" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhiOBOZ3TDAf8HOMoFUf1a0SksrhB7JYkXT2aMb-ft4o9W3MDJzcKLuIoOTiD3XkNGoUyvCOI3WHsWczmd7WHROdh7ayfzp62mAxtuAV6yUOUHXP1n1462QrzW8dA-sP75SWegU08VoEGKn/s1600/2015-02-20_122151.png" width="320" /></a></div>
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<br />
And here's a constant tax (ie without impact of consumer tax hikes) consumer inflation without energy chart.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJ5zWj7SL29TmFAK4tty4-IgCV9hs_K3hpTyuRmBAFEqPz2Mj96WLGjl3XROwPAv7gRH5Ngb4nnUDpUEtMYbfhrxta3x8OYrtOr-YOAmD8jRewn8ds5AFOHKaJxREspTOdP5cFTfdMK6Km/s1600/2015-02-22_125722.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="166" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJ5zWj7SL29TmFAK4tty4-IgCV9hs_K3hpTyuRmBAFEqPz2Mj96WLGjl3XROwPAv7gRH5Ngb4nnUDpUEtMYbfhrxta3x8OYrtOr-YOAmD8jRewn8ds5AFOHKaJxREspTOdP5cFTfdMK6Km/s1600/2015-02-22_125722.png" width="320" /></a></div>
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<br />
It should be clear from an examination of these charts that there is a strong underlying deflationary trend in Spain (and by implication in the other economies on the southern periphery). This deflation is the result of weak consumer demand, and the impact of this on investment. In addition, this "deflationary moment" coincides with the turning point in working age population dynamics, entailing the possibility that we will see long term deflation, Japanese style. (For more on Spanish deflation <a href="http://edwardhughtoo.blogspot.com.es/2015/02/spains-good-deflation.html">see this post</a>).<br />
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If we are seeing the arrival of long term structural deflation, and with it a process know as secular stagnation (Larry Summer's hypothesis), then the policy of Quantitative Easing recently adopted by the ECB will not be short term in duration, nor will interest rates in Europe move far in the foreseeable future from what has become known as the Zero Bound.<br />
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Certainly the bank of Japan has not been shy in increasing it's balance sheet.<br />
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Yet despite the extensive and ample use of QE and a 40% devaluation in the yen against the US dollar, ex-tax inflation in Japan has been steadily falling back and in December it was down to an annual 0.5%. So obvious is the failure of the policy to really produce sustainable inflation that Shizo Abe policy adviser <a href="http://uk.reuters.com/article/2015/02/23/uk-japan-economy-hamada-idUKKBN0LR0G620150223">Koichi Hamada recently argued</a> that the government could cut the inflation target in half (from 2% to 1%) without any major loss of credibility.<br />
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So it is far from clear that the ECB's attempts to obtain its price stability target of near to 2% inflation will be successful, although the view you take on the issue will depend on what you think the underlying reason for the deflation really is. This inflation quandary is important since meeting its price stability objective is Mario Draghi's principal justification for introducing sovereign bond purchases under quantitative easing. Indeed Mr Draghi has even stated that far from such purchases not being within the banks mandate, not conducting such purchases (or similar policies) would be<b> illegal</b> under the mandate given its price stability objective. <br />
<br />
So, since <a href="http://www.ecb.europa.eu/press/pr/date/2015/html/pr150122_1.en.html">QE has been introduced until <b>at least</b> September 2016</a> the possibility exists that it will be continued beyond that point. Indeed it's hard to see how it won't be. And this difficulty in terminating QE will not only relate to inflation insufficiency, debt sustainability will also form part of the picture. Let's take an example.<br />
<br />
<span style="font-size: large;"><b>QE and the French Deficit</b></span><br />
<br />
The ECB has announced that 50 billion Euros in government bond purchases will be conducted monthly between March 2015 and September 2016. That means a total of around 900 billion Euros. Of these purchases 12% - ie around 100 billion Euros worth - will be purchases of EU institution instruments (not national government ones). So total sovereign bond purchases will be around 800 billion Euros. These will be bought by ECB (or national central banks) in proportion to Euro Area GDP shares.<br />
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<br />
Now France accounts for around 20% of EA GDP. So we should expect about 160 billion Euros in French bond purchases during 2015/2016. At the same time, the French government deficit is around 4% of French GDP, or an annual 90 billion Euros a year. The conclusion is that the vast majority of this new deficit will be effectively bought by the ECB. Not only that, this debt will be essentially free of interest service charges, since under the <a href="http://en.wikipedia.org/wiki/Seigniorage">seigniorage principal</a>, the French government will recover the interest paid to the ECB (or the national central bank). Obviously this is what I call "money for nothing and your debt for free".<br />
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<br />
So far, so good. The ECJ gave the opinion that this didn't amount to debt monetization as long as the purchases clearly took place in the secondary market. But let's think about the longer term implications.<br />
<br />
<span style="font-size: large;"><b>Once You Are In QE How the Hell Do You Get Out</b><b>?</b></span><br />
<br />
As is widely know, Japanese gross government debt currently constitutes around 245% of Japan GDP. About 30% of that (or 80% of Japan GDPs worth) is now in the hands of the Bank of Japan. This - as explained above - now effectively costs the Japanese government nothing more than the admin costs of handling so many bonds. The proportion of GDP the BoJ stock of bonds constitutes is rising by the month. The other part of the debt (in private hands) costs, thanks to Japanese QQE, very little to maintain as yields have been driven to a very low level (0.4% on 10 year at the time of writing).<br />
<br />
Now let's imagine that at some point the Bank of Japan ends QQE. (This again is what is normally called a thought experiment, since if I am right it simply won't happen). In the first place Japanese bond yields would start to rise on new debt issuance sold to the private sector, while the part of the debt which is "for free" would become less and less as BoJ holdings steadily mature. The debt, remember is very large. This move would constitute an ongoing fiscal tightening (over several years) since interest service debt costs rising would mean less revenue available for government spending, or less demand in the economy. This tightening would almost certainly provoke a relapse of the fragile Japanese economy and most likely induce a return to deflation (if, that is, Japan had ever really managed to leave).<br />
<br />
It seems clear to me at least that Japan can now never completely exit some form of QE, at least it can't do so without going through a major restructuring of its sovereign debt, and a major shake up in its financial system.<br />
<br />
<span style="font-size: large;"><b>Going's On Behind The Veil Of Financial Ignorance</b></span><br />
<br />
Now lets turn to Europe, and Greece: the country with the second highest gross sovereign debt level globally (175% of GDP). Now the change in government in Greece has bought to the headlines the fact that this sort of debt level is not sustainable, unless someone else makes your debt effectively interest free. The Greek finance minister wanted to declare the country bankrupt, and accept the debt could not be paid. But the Euro Area partners rejected this, and preferred to maintain the fiction of sustainability. More money for nothing and your debt for free is the solution that has been found to maintain that fiction. The significance of the recent Greek deal is that things are essentially going to remain that way.<br />
<br />
In a <a href="http://www.ecb.europa.eu/press/key/date/2014/html/sp140709.en.html">speech given in Athens last year</a>, ECB Executive Board member Benoît Cœuré,referred to Rousseau's "veil of ignorance" initial condition for agreeing on a social or fiscal contract, but maybe more to the point would be the "veil of financial ignorance" which surrounds EU decision making, and effectively means the majority of citizens have little idea of what is really going on. Some even talk of "protecting taxpayers' money in Greece" in relation to the EFSF loans, as if some actual money -rather than debt instruments and guarantees - had changed hands. Greece isn't going to pay back its debt to the official sector, nor will Euro partners ever have to recognise losses on money they haven't actually leant: the ECB can buy EFSF bonds to the appropriate amount and the matter will rest there, possibly with the bonds being renewed every 20, 30 or even 50 years.<br />
<br />
So then work down the queue, to Portugal and Italy with gross sovereign debt levels of around 130% of GDP and rising.These debt levels are not sustainable either, unless that is someone is going to relieve you of your interest service charges, in which case such debt becomes merely an accounting problem. Enter the ECB.<br />
<br />
But for the same reason I mentioned in the Japanese case, once the central bank has bought sufficient quantities of this debt, I simply don't see how we can ever move back to the initial position, without at least serious debt restructuring. The respective economies simply couldn't stand it. Italy's long run trend growth rate is nearly negative, and Portugal's isn't much better. <br />
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<br />
All of this will make policymakers in Portugal and Italy very wary of any kind of Euro exit, and increasingly so as debt levels and ECB bond purchases increase.<br />
<br />
<span style="font-size: large;"><b>Favorable Winds Move All Boats</b></span><br />
<br />
The Euro crisis has come a long way since the heady days of May 2010. A large part of the transition which has taken place has been the responsibility of one man: Mario Draghi. First through his "whatever it takes" speech of July 2012, which marked a watershed in the crisis, opening the period of declining sovereign bond yields. And secondly in a<a href="https://www.ecb.europa.eu/press/key/date/2014/html/sp140822.en.html"> key speech made at the central bankers forum in Jackson Hole in August 2014</a>. This speech - which was actually rewritten during the gathering with the ECB having to amend the original version on its website - was historic in that it was the first time the ECB President explicitly recognized that Euro Area 5 year inflation expectations were not "well anchored". It thus paved the way for the eventual introduction of QE.<br />
<br />
The speech was also important since he laid down a three point plan:<br />
<br />
i) monetary easing at the central bank<br />
ii) structural reforms by national governments<br />
iii) expansionary fiscal policy in those countries which had "fiscal space" - ie capacity to run higher deficits.<br />
<br />
This plan looks very much like a Euro-specific version of Abenomics "light". Progress has been made on the first two points, but so far the response from Germany on the third item has been less than negative. In fact the country is proudly paying down its debt. Without taking this situation into account it is impossible to understand what has happened over the last few days with regard to the Greek bailout negotiations.<br />
<br />
Billed widely in the press as a "great" victory for Germany, and a major humiliation for Syriza the outcome is in fact neither. The main victors (if such a name be relevant) have been - oh irony of ironies - the Troika (henceforth known as "the institutions"). In fact we are talking about the ECB (Mario Draghi), the IMF (Christine Lagarde) and the EU Commission (Jean Claude Juncker). There is basic agreement between the leaders of these three institutions that Greece was subjected to excessive austerity at the time of its first programme (the IMF have even made self-criticism over this), and that at a time of extended low inflation/deflation and worries about the settling in of deflation expectations further austerity is inappropriate.<br />
<br />
Draghi's Jackson Hole plan is in reality the plan of Christine Lagarde and Jean Claude Juncker as well - indeed Draghi even explicitly mentions Juncker's 300 billion Euro insfrastructure plan in his August speech, so it would not completely surprise me to find that the ECB EU institutional purchases involved some related to the European Investment Bank and its financing of the project.<br />
<br />
If you add to the Troika the "coalition of the willing" lead by Francois Hollande and Matteo Renzi (both of whom want some deficit relaxation) it isn't hard to see that it was Germany, and in particular the country's finance minister Wolfgang Schaüble, who was isolated, and basically cornered in the Finmin EuroGroup where Germany effectively have a veto (something they don't have on the board of the ECB, which is why much of the current "action" is centered on that institution).<br />
<br />
So some sort of coherent policy is now being implemented in Europe in response to the regions long standing low growth issues. It's not clear that the measures being taken will serve to remedy the issues they were brought into being to address, but they will have long term consequences and they will make the currency union participants act more like one coherent whole, and in that sense they are to be welcomed. It may be that there is no real "solution" to the long term deflation issue, in which case other measures will eventually have to be found. But neither is having one weak country after another sliced off and savaged in the bond markets any more satisfactory as an outcome.<br />
<br />
What we could be seeing is the birth of a transfer union with the specificity that there will be no actual inter-country transfers. If things are happening in this peculiar way then that will be because this is the EU, and this is how things are done here. It could be, of course, that the basic premiss that contemporary deflation has demographic roots is false. In that case none of this will happen, and put this post down to idle speculation, a mere fantasy world which never has and never will exist. But are you really sure enough that it is false to be willing to do that?<br />
<br />
<b>Postscript</b><br />
<br />
The above arguments are developed in much more detail in<b> the recently revised version </b>of my book "<a href="http://www.amazon.com/Euro-Crisis-Really-Over-whatever/dp/1502343436/ref=asap_bc?ie=UTF8"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/dp/B00NKA6PN8">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-84396048490263660062015-02-16T12:53:00.002-08:002015-05-19T12:49:03.530-07:00Spain's "Good" Deflation?Spain's domestic economy is booming, or so the story goes, and in no small part this boom comes thanks to the arrival of what is being termed the "good kind of deflation", the sort everyone would like to have, a world where prices fall, real incomes rise, jobs are created, and everyone gets to live happily ever after. Let's not worry that in the process the boom is steadily transforming an export lead recovery into a domestic consumption - or import driven - one.<br />
<br />
"Deflation is like cholesterol", Economy Minister Luis De Guindos <a href="http://www.cnbc.com/id/102363479#.">told CNBC at the WEF in Davos</a>, "There are two kinds.....The bad one and the good one. In Spain, you know, we have the good kind," So appealing was the story he told I'm surprised many of those in his audience didn't immediately get on a plane to visit the country to try to discover what the secret was. After all, sounds like the next best thing to a free lunch. Wouldn't anyone want some of that?<br />
<br />
Or again, we have Bloomberg's Maria Tadeo, who temptingly <a href="http://www.bloomberg.com/news/articles/2015-02-11/madrid-ready-to-party-as-spain-s-recovery-bolsters-spending-mood">informed her readers last week</a> that "Madrid is ready to party again". "A strengthening economy and a pickup in consumer spending," she said, "are energizing nightlife in the Spanish capital after a perfect storm of record unemployment, tax increases and a smoking ban put more than 400 venues out of business since 2008."<br />
<blockquote class="tr_bq">
“<i>Madrid is a great place to be,” said Javier Bordas, owner of Opium, which he plans to open seven days a week. “You’ve got the football players, celebrities, and people love to party. We’re optimistic.</i>” </blockquote>
It makes you wonder why on earth support for the radical Podemos party is surging at the polls. Surely there must be a catch here somewhere?<br />
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Of course, Maria is only covering a story, an upside-bullish Spain-recovery one, and she does point out that Spain's 23.7% unemployment rate is the second highest in Europe after Greece, but still, it couldn't be that all the intense talking-up of Spain's recovery in domestic demand is also helping to sell some of that <a href="http://www.wsj.com/articles/recovery-has-investors-stocking-up-on-spanish-malls-1423594281">3.34 billion Euros worth of retail commercial property that went under the hammer in 2014</a>, now could it?<br />
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Certainly the story must be a lot more palatable to the clique of property consultants who are currently doing the selling than it is to one of the 4 million Spaniards currently on the credit blacklist run by <a href="http://“Madrid is a great place to be,” said Javier Bordas, owner of Opium, which he plans to open seven days a week. “You’ve got the football players, celebrities, and people love to party. We’re optimistic.”">credit consulting firm ASNEF</a>, who normally can't get hold of credit under any circumstances and will have a hard time joining in the current consumer "boom" even if they have a job. Spain's Economy minister Luis De Guindos <a href="http://www.forexlive.com/blog/2014/11/26/spains-guindos-says-there-is-no-deflation-in-spain-26-november-2014/" target="_blank">put it even more graphically</a>:
"It’s hard not to defer purchases when you’ve got no money for them in
the first place. In the case of Spanish unemployed I think they’ve got
more worries than waiting for a new sofa suite to drop by €50."<br />
<br />
Nor is the "good deflation" argument especially convincing to anyone with sufficient economic common sense to understand that deflation in a heavily indebted economy can NEVER be unequivocally "good". I doubt there are too many mortgage holders out there busily applauding the ongoing fall in house prices.<br />
<br />
If there is such a thing as "good deflation" it surely comes from falling prices in the wake of productivity gains rather than from "downward stickiness" in wages and pensions. But this is not the Spanish case since employment is growing faster than output. Spain's economy grew by 1.4% during 2014, yet employment was up 2.5%, suggesting that labour productivity actually fell during the year. So Spain's drift downward in prices is being fueled more by a demand shortfall than by supply side improvement: it's hard to see what is so "good" about that.<br />
<br />
My intention here, however, is not to argue that Spain's economic recovery has been hopelessly one
sided, which it has, but rather to try and pick my way through the
ideologically-loaded minefield of arguments which are currently being
advanced about the significance and meaning of the deflation phenomenon in Spain.<br />
<br />
<span style="font-size: large;"><b>So, Is Deflation A Problem? </b></span><br />
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<blockquote class="tr_bq">
<i>"Deflation is a protracted fall in prices across different commodities, sectors and countries. In other words, it is a generalised protracted fall in prices, with self-fulfilling expectations. Therefore, it has explosive downward dynamics." - Mario Draghi</i></blockquote>
One of the reasons the arrival of deflation in Spain has generated so much controversy, I think, is that many doubt the country is actually suffering the phenomenon at all (see <a href="http://www.teinteresa.es/dinero/BANCO-ESPANA-DESCARTA-DEFLACION-RECESION_0_1255075857.html" target="_blank">Bank of Spain Governor Mario Linde</a>, "deflation risk in Spain continues to be low - November 2014 - or <a href="http://www.channelnewsasia.com/news/business/spain-not-sliding-into/1528816.html" target="_blank">Economy Minister Luis De Guindos</a>, "Spain is not at risk of sliding into deflation" - December 2014). Beyond policy makers and those whose job it is to "talk up" the Spanish recovery there is also little perception that it is a real issue, possibly because many have come to doubt so many of the things the administration says that they aren't even sure yet prices are falling. Beyond petrol and house prices the fall is so small it's not easy to perceive, especially when reductions are not shown in the form of like for like changes, but in the form of more complex "offer" and "discounts".<br />
<br />
In fact statistics show that consumer prices were down in January by 1.5% over January 2014, while the GDP deflator for the whole of 2014 (the figure that is used to estimate the impact of inflation on overall output) was estimated at minus 0.7%, meaning that the inflation corrected rise in GDP of 1.4% was only half that number, so, statistically speaking at least, it is important.<br />
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But beyond those who simply - perhaps for definitional reasons - doubt that Spain is experiencing deflation rather than simple disinflation there are those who doubt falling prices really constitute a problem. This is the so-called "good deflation" argument. The FT's Tobias Buck sums up many of the arguments in his article "<a href="http://www.ft.com/intl/cms/s/0/aa1c7bbe-a159-11e4-bd03-00144feab7de.html#axzz3QgTQz9Hp" target="_blank">Spanish Consumers Defy Deflationary Gloom</a>",and economist/blogger Shaun Richards <a href="https://notayesmanseconomics.wordpress.com/2015/01/29/falling-prices-are-providing-an-economic-boost-for-the-ukspain-and-ireland/" target="_blank">has a more theoretical version of the argument here</a>.<br />
<br />
The gist of the "good deflation" case is pretty simple: on the one hand countries like Spain need falling prices and some kind of "internal devaluation" in their ongoing attempt to restore international competitiveness, and on the other consumers aren't "so" rational as to engage in long and complex calculations across infinite time just to work out whether it is better to purchase now-or-later products whose price is falling by only 1% a year. <br />
<br />
At this point it is perhaps worth noting what Mario Draghi says deflation is. Deflation, he tells us, "<i>is a generalised <b>protracted</b> fall in prices, accompanied by <b>self fulfilling expectations</b> which has explosive downward dynamics</i>".<br />
<br />
Well in this sense little in the way of conclusions can be drawn from Spain's initial contact with falling prices, since hasn't been that protracted (yet) and certainly has not developed self-fulfilling expectations: most people in Spain regard the situation as transitory. The self fulfilling part of the definition relates to the possibility of a downward wage-price spiral which mirrors the kind of spiral we see under inflationary dynamics but in the opposite direction. As prices fall, then wage reductions can be offered - as we have seen in Japan - to maintain real wages constant and these wage cuts then fuel further drops in prices. None of this is very evident in Spain so far, even if wages have fallen at some points in the crisis, and with this being election year, the process is unlikely to take hold in 2015.<br />
<br />
As for the "explosive dynamics", I presume the explosive part refers to the impact of a wage price downward spiral on debt affordability, since debt to income ratios are constantly pushed up.<br />
<br />
The idea that economies move into an outright contraction spiral simply because a small fall in prices is repeated over a number of years is a curious one, whose origin isn't clear, and whose reality is to some extent denied - as FT Alphaville's Matthew Klein points out in a post entitled "<a href="http://ftalphaville.ft.com/2014/12/04/2059371/did-japan-actually-lose-any-decades/" target="_blank">Did Japan Actually Lose Any Decades</a>" - by the fact that Japan's economy is widely believed to have performed "tolerably well" all through the deflation years, with weaker consumption growth being more due to declining population (a problem which may also affect Spain in the future) than it is to a supposed phenomenon of "purchase postponement". It's only when you start to look at Japan's 245% debt to GDP level that you get to see where there might be a problem.<br />
<br />
Even in the case of technological products, where price falls are constant and significant, people seem more likely to look for a combination of price and performance, since improvements are ongoing and unending, yet people do buy.<br />
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So if people are largely agreed that small but constant price falls don't, in and of themselves, produce widespread purchase postponement, and recognize in addition that Spain needs weaker inflation than Germany, then, you might ask yourself, why on earth are policymakers worried by the phenomenon? Yet worried about it they are, since if they weren't why would the German government be acquiescing in sovereign bond purchases at the ECB (which in principle it is opposed to) to try to stop it digging in for the long haul? <br />
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Assuming you don't write this institutional concern off as yet another example of things only economists worry about, and go on to ask the question you are likely to encounter three basic explanations: i) not all price falls are small, ii) there is an interest rate impact and iii) those who are burdened by debts become even more burdened as time passes.<br />
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<span style="font-size: large;"><b>Purchase Postponement in Housing </b></span><br />
<br />
Spanish housing offers us a clear example of something whose price has fallen considerably, around 40% since the 2007 peak, and whose price continues to fall (currently in the 3% to 5% per annum range).<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhraCGTLVtmeLJDzHTl5L3tk2Z3rdDD5os10c9Tn6ylqfqJRh7Vdm3cnGbVG8nrhhCJVWyymA0Z7UTQFi0DbGuptsYAeeJtaC7uSeVCZeexWd0us8Y1XezarGpTB7zGldB8brRyP0UD85Q/s1600/2015-01-15_091856.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="175" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhraCGTLVtmeLJDzHTl5L3tk2Z3rdDD5os10c9Tn6ylqfqJRh7Vdm3cnGbVG8nrhhCJVWyymA0Z7UTQFi0DbGuptsYAeeJtaC7uSeVCZeexWd0us8Y1XezarGpTB7zGldB8brRyP0UD85Q/s1600/2015-01-15_091856.png" width="320" /></a></div>
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Far from this fall in prices having stimulated demand - the deflation "consumption boom" argument - we are witnessing exactly the opposite effect: demand has collapsed, and is not recovering significantly (see my piece from April 2014, "<a href="http://edwardhughtoo.blogspot.com.es/2014/04/firmly-anchored-expectations-no.html" target="_blank">Firmly Anchored Expectations, No Postponement of Purchases?</a>"). This is not surprising, since housing is a special sort of good (combining both use and investment) and the market is one where price movements tend to be self re-inforcing.<br />
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The Spanish housing market is still far from functioning normally - the number of new houses purchased in December was just over 7,000 - the lowest monthly level in more than a decade.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgVhRXiOubHt_D23HWI_qA50s6nA-rqYpPHq4IL67NmYe-lbtEI-863KtCmtelQaxrEj56vURKp3iP7GB3t-fMPIfunyiX8NEvaiCz_ir7pBoJfBCWy0u7lZJgVVOZyMKSCAQhwGaSNwYA/s1600/2015-02-10_092736.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="189" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgVhRXiOubHt_D23HWI_qA50s6nA-rqYpPHq4IL67NmYe-lbtEI-863KtCmtelQaxrEj56vURKp3iP7GB3t-fMPIfunyiX8NEvaiCz_ir7pBoJfBCWy0u7lZJgVVOZyMKSCAQhwGaSNwYA/s1600/2015-02-10_092736.png" width="320" /></a></div>
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True, the number of second hand houses being purchased is rising, but even the combined total is far from showing a sharp rebound.<br />
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Perhaps the most worrying thing about the fact that second hand purchases are improving while new ones aren't is that part of the explanation for this is that properties become reclassified as "used" 2 years after completion (so some of the second hand houses being sold are in fact new), but this makes the situation with new houses deeply preoccupying, since there are more than half a million unsold housing units still classified as "new" (see <a href="http://www.idealista.com/news/inmobiliario/vivienda/2015/01/12/733817-la-realidad-de-por-que-se-venden-menos-viviendas-nuevas" target="_blank">this article</a> on the Spanish property website Idealista) which means they have been built within the last two years.<br />
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The problem with the arrival of deflation in Spain is this is going to create an environment where it becomes even more difficult for the housing market to really recover. In the meantime, constantly falling prices have had one consequence: Spaniards now prefer renting to buying, they have become more aware of the risk involved in owning a property. So perhaps rather than simple purchase postponement process what we should be looking for are a broader set of behavioral changes over the longer term.<br />
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In any event, given the importance of the Spanish housing market to the economy in general - 75% of the country's household wealth is tied up in property - the situation cannot be ignored: ending deflation in Spain would help push house price movements back into positive territory, and in so doing would give a significant boost to the Spanish economy.<br />
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<b><span style="font-size: large;">Then There Are Borrowing Costs</span> </b><br />
<br />
Moving beyond the issue of the supposed "purchase displacement effect", Mario Draghi has a rather more powerful argument: the interest rate impact. Consumption growth in modern economies is as much about credit as it is about spending from current income. Too many people are still thinking about economic dynamics in terms of confidence and money stored under the mattress, or as some whit of a Bloomberg journalist put it, <a href="http://www.bloomberg.com/news/articles/2015-02-03/greeks-spooked-by-debt-clashes-put-cash-under-bathroom-tiles">burying it beneath bathroom tiles</a>. Credit matters to modern economies, as we have seen during the recent "credit crunch". As consumer credit accelerates, economies grow, and normally when this happens central bankers started raising interest rates to slow credit growth. In general I think it is fair to say that those who think there is "good deflation" in Spain and those who think Spanish deflation is "not so good" agree about this. <br />
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Yet credit, curiously, is all about the temporal displacement of purchases. When credit is cheap, and inflation is expected to be present, consumers tend to advance purchases. I don't know whether anyone wants to challenge this, but it is the cornerstone of any kind of interest rate policy. It is what gives the central bank, under normal conditions, the ability to apply counter cyclical policies in the face of recession. If this mechanism doesn't work, then there is a problem in the whole way we have been thinking about things.<br />
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Once interest rates reach the zero bound (I think it is impossible to separate discussion of deflation from the issues which arise in the context of a zero bound) then this mechanism hits a limiting factor, since while prices are in negative territory conventional central banking theory makes bankers reluctant to follow by taking interest rates even deeper into negative territory (although, it should be said, we are now increasingly seeing the negative nominal interest rate phenomenon in countries like Sweden, Denmark and Switzerland). As Mario Draghi put it <a href="http://www.ecb.europa.eu/press/pressconf/2014/html/is141204.en.html" target="_blank">answering questions at the ECBs December 2014 press conference</a>: <br />
<blockquote class="tr_bq">
<i> "Now, let me make absolutely clear that we won’t tolerate prolonged deviations from price stability, and the main reason is that if these deviations feed into inflation expectations, they’ll cause a drop on medium to long-term inflation expectations, which by the way still are within a range consistent with medium-term price stability. But if these were to feed into inflation expectations, these lower outcomes of inflation, were to feed into lower inflation expectations, we would have a zero lower-bound nominal interest rate. This would be tantamount to an increase in the real interest rate." </i></blockquote>
Here we find some key word expressions:<b> prolonged deviations from price stability</b>, <b>lower long-term inflation expectations</b>,<b> increase in real interest rate</b>. This situation is rather different from the one described by the Spanish economist Javier Andrés in <a href="http://www.ft.com/intl/cms/s/0/aa1c7bbe-a159-11e4-bd03-00144feab7de.html#axzz3RWzTKDkb" target="_blank">the Tobias Buck article</a> I mentioned earlier: “The fall in prices", Andrés argued, " is not strong enough, nor is it perceived to last that long, as to make it worthwhile for consumers to postpone the purchase of goods.” In Spain at the moment the deviations from price stability have not been strong enough or perceived to have lasted long enough to have an impact on consumer expectations.<br />
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In fact deflation has been settling in for a lot longer than people in Spain think it has. Many still believe that the recent negative inflation is simply the result of a negative oil price shock, but if we look at the EU HICP rate excluding energy it is clear that the deflation issue started a lot earlier.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi5I17hmvEcCIlQnwN0NTAzM3X-IMhfql1ohd9Yv0iWn4UolytfbbrR9z2_ndUf3I533WXzoKqKSLuazesQRWew6iW4w8eRsotoH0PmoD_DhriFO0K_Tz0kQdTWuKD1bSfH0aizrVeo0p8/s1600/2015-02-20_122151.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="167" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi5I17hmvEcCIlQnwN0NTAzM3X-IMhfql1ohd9Yv0iWn4UolytfbbrR9z2_ndUf3I533WXzoKqKSLuazesQRWew6iW4w8eRsotoH0PmoD_DhriFO0K_Tz0kQdTWuKD1bSfH0aizrVeo0p8/s1600/2015-02-20_122151.png" width="320" /></a></div>
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<br />
Another issue which has clouded the Spain deflation issue has been the use of consumption tax increases as a deficit reduction measure.The national statistics office maintain an ex-tax estimated EU HICP inflation rate, rather like the one the Bank of Japan maintains following the consumption tax rise in that country. Obviously if you raise a consumption tax you raise inflation, but this kind of inflation is not thought to be positive (as we are seeing in Japan, the country fell back into recession after the increase) as it weakens consumption (as the various VAT rises have in Spain). <br />
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The ex-tax consumer price index tries to estimate underlying inflation without the tax, and - as the chart below reveals - if we use that measure Spain has been hovering in deflation territory since late 2012. However Spain's citizens seem to have a kind of "inflation bias" after many years of highish inflation, and simply refuse to believe that prices really have started falling.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgbKe-zgxlOL5cj9cZJUILVNrQNfUaTGf4uzci6IbqCF0IoqjISL7pYH6AlzgkcK7-vpJN81OzzB0AlrIgwM6UfQLnb_vF3bkmdI6qIzbLCUiMne93qem6X6-vxUQaiVYVjWSWwH58bH-Qi/s1600/2015-02-15_134228.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="200" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgbKe-zgxlOL5cj9cZJUILVNrQNfUaTGf4uzci6IbqCF0IoqjISL7pYH6AlzgkcK7-vpJN81OzzB0AlrIgwM6UfQLnb_vF3bkmdI6qIzbLCUiMne93qem6X6-vxUQaiVYVjWSWwH58bH-Qi/s1600/2015-02-15_134228.png" width="320" /></a></div>
In fact if we now adjust that earlier HICP excluding energy data and produce a constant tax version, we get a chart which looks like this.<br />
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This suggests that Spain has been near to deflation ever since the global financial crisis struck, but that the initial recovery produced an inflation surge as wages and prices across the economy reacted upwards (price rigidity, things going back to normal in terms of expectations). Now that shock has passed and the underlying trend towards deflation becomes obvious.<br />
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Mr Draghi is worried (although NOT Mr Linde, or Mr De Guindos, as we have seen) that if the current trend is not corrected Spain's citizens might eventually begin to believe and expect it, which is why he gives more importance to the issue and is taking measures accordingly. Indeed, such is the importance which EU - as compared to Spanish - policymakers give to the issue they are taking the measures even though their mere announcement has started causing a great deal of difficulty for central banks in countries like Switzerland, Sweden and Denmark. Again, it is noteworthy how by and large these central bankers are accepting such difficulties without protesting too much since they understand why Mario Draghi feels forced to implement them.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnBnw0hBQgdyDxdkFeUHve68cVYSqv7U1zis5k3234zehXKWgplmUO8vp-N6wyYAflZMnGz9ID9TJl8eaQi5XvkxRyQD35AxAFyCCFXCMR2X9XIUorxPmYkecMR0B5fZTzDgWwGwiz6maG/s1600/2015-02-17_093856.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="168" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnBnw0hBQgdyDxdkFeUHve68cVYSqv7U1zis5k3234zehXKWgplmUO8vp-N6wyYAflZMnGz9ID9TJl8eaQi5XvkxRyQD35AxAFyCCFXCMR2X9XIUorxPmYkecMR0B5fZTzDgWwGwiz6maG/s1600/2015-02-17_093856.png" width="320" /></a></div>
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Mario Draghi argues that falling inflation expectations<b> raise real interest rates</b> by influencing the perceived cost of credit into the future. If consumers anticipate inflation, then that makes borrowing cheaper and people tend to advance purchases. Conversely expected price falls make the cost of borrowing greater, make the desirability of advancing purchases via credit less, and in this sense constitute monetary tightening. I am aware of an ongoing debate about whether interest rates really are a key factor influencing investment decisions, but I have never seen an argument suggesting that the cost of credit does not influence consumption. And so it is in Spain, since the demand for household borrowing is not surging, even though the country's banks keep telling us they are now "<a href="https://twitter.com/bloombergtv/status/558180122055176192" target="_blank">ready to lend</a>".<br />
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<span style="font-size: large;"><br /></span>
<span style="font-size: large;"><b>Deflation Favors Savers Not Debtors</b></span><br />
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Deflation obviously favors those with money in the bank (unless <a href="http://www.wsj.com/articles/danish-lenders-take-unprecedented-steps-to-combat-negative-interest-rates-1423576590">the banks start charging negative rates on time deposits</a>) since the value of money steadily goes up. It is not so kind on those with debts, since as prices and incomes go down, debts remain unchanged and the burden of paying them increases.<br />
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Spain is an endebted country - the net international investment position (NIIP) is negative to the tune of around 100% of GDP - so it isn't the first place that comes to mind when you think of some kind of "good deflation" process. Japan, in comparison, has a positive NIIP of around 50% of GDP, making it a very different case.<br />
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The various sectors in Spain's domestic economy are also very highly indebted, and the combined debt of government, households and the business sector comes to about 275% of GDP, not that much less than it was at the start of the crisis. This is because while household and corporate debt has reduced, government debt has increased considerably. All of this means that if deflation sets in it will be a serious problem for Spain.<br />
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Spain's external correction still has some way to go in terms of price competitiveness, but having so called "good" competitiveness recovering deflation is not the way to do it at this point, due to the debt impact. This is why ECB policy is directed towards trying to stimulate Euro Area inflation, since obviously if countries like Germany had 2% annual inflation and Spain and others had 0.5% the correction would be a lot less fraught with problems.<br />
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<span style="font-size: large;"><b>Why Is It Likely Deflation Will Continue In Spain?</b></span><br />
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There are basically two theories why Eurozone countries are suffering from deflation at the moment. One of these is the idea of <a href="http://en.wikipedia.org/wiki/Debt_deflation">debt deflation</a>, whereby over-indebtedness creates a consumption drag leading to a shortage of consumer demand while countries deleverage. This is certainly part of the problem that Spain is experiencing.<br />
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But there is second theory going the rounds ever since it was put into circulation by US economist Larry Summers <a href="https://www.youtube.com/watch?v=KYpVzBbQIX0">at an IMF research conference in the autumn of 2013</a>. The hypothesis Summers advances is based on ideas developed by <a href="http://conversableeconomist.blogspot.com.es/2013/12/secular-stagnation-back-to-alvin-hanson.html">Alvin Hansen in the 1930s</a>, and the essential point is that countries like Japan and those in the Euro Area are experiencing some kind of demographically driven secular stagnation. This is not the place to go into this theory in any depth, but basically the idea is that as working age population growth slows, comes to a halt and then turns negative consumer demand starts to weaken and eventually decline. This affects the investment process, and it is the structural "underinvestment" which produces the demand shortfall which means there is constant downward pressure on prices.<br />
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Paul Krugman provides a useful summary of the argument in his blog post - "<a href="http://krugman.blogs.nytimes.com/2014/05/19/demography-and-the-bicycle-effect/?_php=true&_type=blogs&_php=true&_type=blogs&module=BlogPost-Title&version=Blog%20Main&contentCollection=Opinion&actio&_r=0">Demography and the Bicycle Effect</a>" - and I offer a summary <a href="http://edwardhughtoo.blogspot.com.es/2014/06/secular-stagnation-part-1-paul-krugmans.html">here</a>.Of course, at this point it is only a hypothesis - the worrying thing is that in Spain the possibility that this might be happening hasn't even been considered, let alone rejected.<br />
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<span style="font-size: large;"><b>So What Is It - Good or Bad Deflation?</b></span><br />
<br />
At the moment Spain's citizens have mainly seen only the good side of deflation: wages and pensions were up while prices fell. Spanish hourly wages rose an annual 0.6% year on year in October 2014 (last date for which we have available data) according to Eurostat, Spain's pensions were up 0.25% (despite the pension system running a loss of 1.3% of GDP) while consumer prices were down 1.1% year on year in December. In addition 400,000 new jobs were created during the year. It is little surprise then to discover that the statistics office report that price corrected retail sales were up 1% on the year in 2014.<br />
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The question is, what happens next? Do workers and pensioners continue to receive above cost-of-living wage and pension increases? This being election year the chances are they do, which means more pressure on profit margins and more withdrawals from the pension reserve fund. And in the longer run, is this sustainable, or will wages and pensions start to fall in line with prices, producing the so called "spiral"?<br />
<br />
To get answers to these questions we will need to wait to see in the years to come, but in the meantime important changes may be occurring in consumer behaviour, not only in attitudes towards house purchase, or in terms of any supposed "postponement" activity, but simply in the way people are becoming more sensitive to price movements and bargains. In this context, Justin McCurry's New York Times article on the Japanese experienece - "<a href="http://www.theguardian.com/world/2015/jan/11/japan-deflation-consumers-falling-prices-gyudon">Spectre of deflation horrifies bankers, but Japan now has a taste for it</a> - makes interesting
reading. In particular his conclusion:<br />
<blockquote class="tr_bq">
<i>"Spending habits honed over 20 years die hard. And if Japan’s experience can teach Europe anything, it is that government attempts to haul consumers out of the deflationary abyss are fraught with difficulty. An entire generation has come to embrace the deflationary devil they know. For the population at large, what started life as a reluctant thrift habit borne of necessity has quietly become the economic version of the Stockholm syndrome."</i></blockquote>
And <a href="http://moneymorning.com/2010/07/08/real-housewives/">here's another piece</a> of evidence from Japan (The Real Housewives of Japan: Shopping for Bargains … Driving Deflation?) highlighting how years of deflation have lead customers to expect price discounts, and have come to leverage online and social media in the search for ever better bargains.<br />
<blockquote class="tr_bq">
<i>Could 70,000 Japanese housewives tip this Asian giant into a deflationary spiral?
As farfetched as that sounds, it's become a major cause for concern in this nation of 128 million, which has been in an economic funk for two decades. These "real housewives" are part of a user-driven, social-networking site called Mainichi Tokubai, which delivers the best prices on specific grocery-store items to the fingertips of Tokyo-region consumers.
To hear frustrated Japanese policymakers and retail executives tell it, these bargain-minded consumers and their equally frugal social-networking site are almost-single-handedly undercutting the Japanese economy.</i></blockquote>
The above article particularly caught my attention since<a href="http://blogginzenith.zenithmedia.es/rebajas-y-compras-online/"> this is a phenomenon which is increasingly to be seen at work in Spain</a>: people shopping around and expecting bargains, and using online media to help them in their search. In deflationary times the evidence suggests the rise of a kind of "consumer power" where people come to expect permanent sales and discounts and virtually force these on retailers, to the great disadvantage of the small, local shop. This kind of behaviour obviously fuels deflation and when entrenched it is hard to change as Stanley White noted<a href="http://www.nytimes.com/2012/12/18/business/global/deflation-a-determined-foe-in-japan.html?_r=1&"> in a 2012 Reuters article</a>.<br />
<blockquote class="tr_bq">
<i>"A bargain-hunting psychology is so entrenched in Japan — after two decades of stop-start economic growth, 15 years of falling wages and nearly 15 years of deflation — that the government will struggle to convince people that their incomes will improve enough for them to buy more expensive goods.</i></blockquote>
Spanish policymakers take note, and think twice in future before you say Spain is simply suffering from "good deflation".
<b> </b><br />
<br />
<b>Postscript</b><br />
<br />
The above arguments are developed in much more detail in<b> the recently revised version </b>of my book "<a href="http://www.amazon.com/Euro-Crisis-Really-Over-whatever/dp/1502343436/ref=asap_bc?ie=UTF8"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/dp/B00NKA6PN8">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-25839213790026336272014-12-30T13:05:00.000-08:002014-12-29T23:18:49.433-08:00It's Baaack: Looming Greek Elections Threaten To Re-ignite the Euro CrisisIf at first you don't succeed, try, try again...... aka third time unlucky.<br />
<br />
The Euro crisis has all the signs of being back amongst us, and this time it may be here to stay. After two earlier false alerts - one in July <a href="http://theconversation.com/the-espirito-santo-crisis-threatens-a-new-phase-of-european-bank-anxiety-29110">around the collapse of the Portuguese Banco Espirito Santo</a>, and another in October <a href="http://www.cnbc.com/id/102089687#.">over the state of the Greek bailout negotiations</a> - the announcement in early December that the Greek presidential selection process was being brought forward to the end of the month sent markets reeling off into a complete tizzy.<br />
<br />
In a development reminiscent of the heady days of 2012 yields on Greek 10yr bonds surged over a percentage point in the two days following the announcement, while the stock market fell by the most on a single day since 1987. 5yr CDS on Greek debt were also up sharply, and even more significantly, the yield curve inverted with 3 year debt started to move above that on ten year debt. Yield inversion on sovereign bonds is often seen as a symptom of potential default as investors demand ever more for holding short term debt. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhgjcUuqjo6SyVrSoJg65pkjga43u_RzfUHrTU2gGQcqYTEoPS556Oqxu93jPn-8Zm7BdbXAiE52UK0NPTo6pHKnXXQ97B-RxxHBEnTy7dwAmmffkZT4bRxeZ72JNLAJk1Szsq3_qQdRjcS/s1600/2014-12-10_185933.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhgjcUuqjo6SyVrSoJg65pkjga43u_RzfUHrTU2gGQcqYTEoPS556Oqxu93jPn-8Zm7BdbXAiE52UK0NPTo6pHKnXXQ97B-RxxHBEnTy7dwAmmffkZT4bRxeZ72JNLAJk1Szsq3_qQdRjcS/s1600/2014-12-10_185933.png" height="210" width="320" /></a></div>
<br />
And the chaos continued all week with 10 yr bond yields rising above 9% and stocks falling another 7.35%, taking the total drop in equities to over 20% (chart from <a href="http://www.businessinsider.com/greeces-election-chaos-is-sending-stocks-crashing-again-2014-12">Mike Bird at Business Insider</a>). <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg31H9UBGXP3hPxx2VHHge1udGxZTnT18910vRcIRWZnvFOlebc8V6r5jnR6XyNf9rKxVJIz-_mrIN50OnJIe4Uzx_2hO4IWPrda4zAaoBxTcDg0qho-U7bw3zdjVQ6c-UEFNnHxvmHkLef/s1600/2014-12-11_162854.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg31H9UBGXP3hPxx2VHHge1udGxZTnT18910vRcIRWZnvFOlebc8V6r5jnR6XyNf9rKxVJIz-_mrIN50OnJIe4Uzx_2hO4IWPrda4zAaoBxTcDg0qho-U7bw3zdjVQ6c-UEFNnHxvmHkLef/s1600/2014-12-11_162854.png" height="318" width="320" /></a></div>
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The reason for the market panic is obvious, since investors didn't need long to study the Greek constitution and realise that should the current government be unable to summon sufficient votes for their candidate to be approved in the final vote on 29 December, then general elections would become inevitable.<br />
<br />
With yesterday's vote this possibility has now become a reality and elections are to be held on 28th January 2015. What's more there is a significant possibility that the radical left coalition - Syriza - will win, and in that eventuality some sort of confrontation or stand-off with the EU Commission and the Troika would become inevitable.<br />
<br />
What is worrying investors most is not the fact that Syriza have renegotiation of the country's debt in their programme - with government debt at over 175% of GDP and the economy in deflation some sort of restructuring is inevitable - but the kind of economic programme the new government would try to implement since it would surely be based on a kind of "anti Troika" formula - higher salaries, higher pensions, more government employees, and repeal of the new labour law, just for starters - and these kind of "reverse reform" measures would be hard for Europe's leaders to swallow.<br />
<br />
Formally the party do not seek to leave the Euro, their aim is rather to run an alternative economic model within the Euro structure, based on the assumption that faced with the threat of Greek exit Europe's leaders would back down and become more flexible. Investors are nervous since they fear that they may not do so, and that Greek exit may actually ensue.<br />
<br />
<b>Long Term Depression </b><br />
<br />
Despite the fact Greece's economy grew by 1.6% over a year earlier in the 3 months to September (making for the third straight period of quarterly growth) this welcome "green shoot" comes on the back of six years of contraction during which time the economy fell by around 25%. The country - and it's citizens - is a lot poorer now than it was then, not to mention the fact that it has been burdened with a lot more debt.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiGm3zVGT5E-ez3swdLZNCd2N3rwSYdLKyPt-PWBQILGQAYOyWrX6GtKCS9wAQw07-5fnxZTvQXUCkHExcloK-ksyNr4uv4V81hTUAThyphenhyphenMCAAb8ydiABWr2oCObiVg6Ak5tfaHR3wob1Ni2/s1600/2014-12-11_181124.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiGm3zVGT5E-ez3swdLZNCd2N3rwSYdLKyPt-PWBQILGQAYOyWrX6GtKCS9wAQw07-5fnxZTvQXUCkHExcloK-ksyNr4uv4V81hTUAThyphenhyphenMCAAb8ydiABWr2oCObiVg6Ak5tfaHR3wob1Ni2/s1600/2014-12-11_181124.png" height="185" width="320" /></a></div>
<br />
So while growth has returned, it is very modest growth in relation to the fall which preceded it. In addition the country's economy is suffering from deflation, with consumer prices falling by 1.2% in November over a year earlier, the 21st consecutive month of negative inflation. The IMF now forecast that Greek GDP will grow by 0.6% in 2014, but prices will fall by 0.8% meaning that nominal (non inflation adjusted) GDP will be stationary. And this kind of situation could go on for years and years as the country exists a horrendous recession only to enter an extended period of secular stagnation.<br />
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<br />
Despite the timid, but much applauded, recovery, the macroeconomic data is far from being encouraging, as this screenshot taken from the statistic office website illustrates.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhAQOT3TNBWh9PX3bqzMHvxcgOtNz778p60mT0VY9w95BZmmhnwAaX40sI2H9QNApbZn6A9JCngKLz-BW_2qpVUsQYc5fC0-FXV3wWVx8TLJi9K63b0BISCSxTQOSTkgAu-3APTCZHL7UAD/s1600/2014-12-11_185521.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhAQOT3TNBWh9PX3bqzMHvxcgOtNz778p60mT0VY9w95BZmmhnwAaX40sI2H9QNApbZn6A9JCngKLz-BW_2qpVUsQYc5fC0-FXV3wWVx8TLJi9K63b0BISCSxTQOSTkgAu-3APTCZHL7UAD/s1600/2014-12-11_185521.png" height="107" width="320" /></a></div>
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Industrial output is back where it was in 1976, and was down 1.7% over a year earlier in October.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi02GhRzo-KZ96BQNN2XCkSR-zfD6deR4a-77w1SEa3stB3lDqe6Y4vt2TokPCTw2MHc8eTKC2pl5hP6WabJESE3NbpseqNJjYgzgk6082AXB3ri9miEdilQzNXSU4v4qDVd78ROhhQTRrI/s1600/2014-12-11_185807.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi02GhRzo-KZ96BQNN2XCkSR-zfD6deR4a-77w1SEa3stB3lDqe6Y4vt2TokPCTw2MHc8eTKC2pl5hP6WabJESE3NbpseqNJjYgzgk6082AXB3ri9miEdilQzNXSU4v4qDVd78ROhhQTRrI/s1600/2014-12-11_185807.png" height="220" width="320" /></a></div>
Greece's current account has made huge strides in the right direction, and the balance was even positive in 2013, but this improvement has largely been the result of a reduction in imports (and living standards) and not due to export growth.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhovBmLv4sE22h7KGvYrSpS5tE8ERAY64g4nCSRGroJyDyCRNaTOPCCucdm6S-VpVGspDjm0lTdKst4Pm13UmXCaRQjzA87zGgZk249s7EhuJN7RE7fqXKszMjgXcDviohmoZ06gHgwMBE_/s1600/2014-12-11_192456.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhovBmLv4sE22h7KGvYrSpS5tE8ERAY64g4nCSRGroJyDyCRNaTOPCCucdm6S-VpVGspDjm0lTdKst4Pm13UmXCaRQjzA87zGgZk249s7EhuJN7RE7fqXKszMjgXcDviohmoZ06gHgwMBE_/s1600/2014-12-11_192456.png" height="194" width="320" /></a></div>
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As a result the country still runs a sizable goods trade deficit.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhcmag_pfDkgA6vOiqaM_wm6ckbAdHJ_ujrOrxseftd-yFfaN_190s4Doidr1oBRM5ZfXPHvrdbXpuVj_AGQvzOTqFRmj1hFXD-8Gd2x2qq5lE_LK8jXLfZ_UKngXBDcI9bzNOUBGO8NPbE/s1600/2014-12-11_205406.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhcmag_pfDkgA6vOiqaM_wm6ckbAdHJ_ujrOrxseftd-yFfaN_190s4Doidr1oBRM5ZfXPHvrdbXpuVj_AGQvzOTqFRmj1hFXD-8Gd2x2qq5lE_LK8jXLfZ_UKngXBDcI9bzNOUBGO8NPbE/s1600/2014-12-11_205406.png" height="190" width="320" /></a></div>
<br />
So Greece isn't having an export lead recovery, which is what the country really needs. In fact massive sacrifices have been made, many people's lives have been made a misery, yet there is really very little to show for it all. Which is why Syriza is doing well in the polls. With 26% unemployment continuing, surely (the thinking goes) anything would have to be better. Why not try a long shot in the dark?<br />
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<br />
<b>Whom The Gods Would Destroy They First Make Mad</b><br />
<br />
The horrid little secret about the common currency experiment is that it provided a structure wherein it was very easy to get into trouble (cheap interest, good credit ratings, no current account supervision) but desperately hard to get out of it (no currency to devalue). The big problem for Greece now is to find a way to get the country back to where it was before they got into the current mess while staying inside the currency union? Some would say quite simply they can’t and the conclusion to be drawn is that they should leave the Euro. This isn’t as easy or as obvious a solution as it seems, and in addition many of the other member countries are effectively counter-parties on much of the large external debt that has been accumulated, so in the event of non-payment part of the problem would simply change hands.
Any decision by a member country to cut loose from the Euro is unlikely to be welcomed by the creditor nations, making the idea of a voluntary, negotiated departure pretty unlikely, particularly after Mr. Draghi made his promise. The exiting country would have to do so unilaterally, and face the consequences on debt default and sustained lack of access to international capital markets.
<br />
<br />
It would be a very messy affair, and in some ways not a decision a person applying a rational calculus would be likely to arrive at. There are so many losses to offset against the gains. Under these circumstances the only conceivable way a deliberate decision to leave could credibly be envisioned would be as a result of one or more of the respective agents being effectively driven “insane” by the constant painful efforts involved in trying to carry out the very large competitiveness correction required while remaining within the currency union. This indeed was the argument I advanced in my essay submission to the Wolfson Prize: a procedure for orderly exit is essentially a worthless document since if anyone does leave the affair won't be orderly, but bitter and fraught with conflict. And this phenomenon of growing political instability was what characterized Argentina before it went careering off the tracks in December 2001.<br />
<br />
So just because many might question the rationality of such a decision doesn't mean it won't happen, or couldn't happen as an unwanted side effect of a conflict which gets out of control. Economies on the southern periphery are not recovering (in any normal sense of that word), they are condemned to either frequent recessions or one very long depression, depending on how you classify things, together with protracted deflation and unacceptably high levels of unemployment. The degree of lost competitiveness that was inflicted during the early years of the century - and which is as much an institutional and reputational issue as it is a price one - imply that a decade or more may pass before daylight is seen.<br />
<br />
If it ever is.
This outcome is proving very painful for the respective populations. Too long and too painful, which is why we are now seeing a surge in support for organizations like Syriza, or Podemos in Spain, or the 5star movement in Italy. Confidence has steadily eroded in the old political elites, who were trying to convince voters that pigs really could fly (while in many cases lining their own pockets in the process) and more radical political movements are emerging. It isn't that hard to understand. This was always going to happen.<br />
<br />
Some, <a href="http://www.ft.com/intl/cms/s/0/577efe3a-8080-11e4-9907-00144feabdc0.html#axzz3LZX9n8GY">like the FT's Kerin Hope</a>, try to draw comfort from the idea that Syriza may be moderating as the responsibility of holding power looms. <br />
<blockquote class="tr_bq">
"<i>....the recent market panic belies the fact that Mr Tsipras has softened his rhetoric since Syriza came first in May’s European elections, cementing its lead over the governing New Democracy party in opinion polls.
He professes devotion to the euro while his economic team now holds regular international conference calls in an effort to reassure fund managers that a leftwing government would be able to tackle Greece’s debt problem and would not oppose foreign investment</i>."
</blockquote>
But this may be mistaking tactics for strategy. These movements are not about to get incorporated in the mainstream. And the key issue is not likely to be the debt one. As I explained (<a href="http://edwardhughtoo.blogspot.com.es/2013/06/the-second-battle-of-thermopylae.html">here</a>) in the summer of 2013 formulas exist for handling this question. What is most likely to divide Athens and Brussels if Syriza win the elections is the nature of the economic model the country will adopt. In this sense <a href="http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/11286477/Greek-candidate-willing-to-call-European-leaders-bluff.html">Ambrose Evans Pritchard has this one right</a>.<br />
<blockquote class="tr_bq">
<i>As matters stand, it is more likely than not that a defiant Alexis Tsipras will be prime minister of Greece by late January. His Syriza alliance vows to overthrow the EU-IMF Troika regime, refusing to implement the key demands.
A view has taken hold in EU capitals and the City of London that Mr Tsipras has resiled from these positions and will ultimately stick to the Troika Memorandum.... But the fact remains that he told Greek voters as recently as last week that his government would cease to enforce the bail-out demands “from its first day in office”.</i></blockquote>
In fact they go further, describing Troika representatives as "criminals" who work to convert the periphery into "German colonies". If you listen hard enough you can hear Podemos leaders saying similar things in Spain.<br />
<br />
As Ambrose also points out, Mr Tsipras will be banking on the idea that the EU leaders will back down, and talk turkey. But what if they don't? Their room for manoeuvre on this front is far more limited than it is on the debt one, since others in the south would surely want to follow a similar path if they thought they could. Grexit may be something that no one actually wants to happen, but sometimes things no one wants to happen do.<br />
<br />
<b> Postscript</b><br />
<br />
The above arguments are developed in detail and at far greater length in my recent book "<a href="http://www.amazon.com/The-Euro-Crisis-Really-Over/dp/1502343436/ref=sr_1_2?ie=UTF8&qid=1410776947&sr=8-2&keywords=edward+hugh"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/Euro-Crisis-Really-Over-Whatever-ebook/dp/B00NKA6PN8/ref=sr_1_2?s=digital-text&ie=UTF8&qid=1410812161&sr=1-2&keywords=edward+hugh">including Kindle</a> - at Amazon.<br />
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This post, which was originally published in early December has been updated to take account of the fact that elections have now been called.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-20584556747999557092014-11-16T08:05:00.001-08:002014-11-16T22:39:40.867-08:00Abenomics 2.0 - Just What Are They Trying To Achieve?The recent move by the Bank of Japan to take further measures to accelerate the rate at which it ramps up its balance sheet took almost everyone - <a href="http://www.bloomberg.com/news/2014-10-31/boj-unexpectedly-boosts-easing-amid-weak-price-gains.html">market watchers included</a> - completely by surprise. The consequence was reasonably predictable - the yen has once more fallen strongly against almost all major currencies - and most notably against the USD - and Japan's main stock indexes are sharply up.<br />
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On the other side of the balance sheet the cost of imported goods - and especially energy - is expected to rise, real wages are likely to continue to fall, and ex-tax inflation looks set to remain moderate, possibly around 1% - short of the 2% objective but comfortably away from deflation.<br />
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Meantime this week's GDP figure show's that the country fell back into recession again in the third quarter with a 1.6% annualized drop following one of 7.3% in the April-June period. The headline number makes it likely Abe <a href="http://www.reuters.com/article/2014/11/11/us-japan-politics-election-idUSKCN0IV28D20141111">will go ahead with snap elections in December</a>, and indeed postpone the second stage of the consumer tax hike which was due to be implemented next autumn.Obviously, if what you are trying to do is stimulate inflation then sending the economy regularly into recession by weakening consumption isn't going to help. <br />
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But what all these conflicting signals underline is the lack of clarity about just what the principal objective of Abenomics actually is. Simply creating inflation cannot be the goal. If it is achievable on a sustained basis this inflation has to be a means to something else. For Paul Krugman that something else would be <a href="http://krugman.blogs.nytimes.com/2013/10/27/ppp-and-japanese-inflation-expectations-extremely-wonkish/">a lowering of the real interest rate via rising medium term inflation expectations</a>. This lower real rate would - so the theory goes - stimulate investment in capital goods and hence provoke an ongoing (and self sustaining) recovery in the Japanese economy after years of sub-par growth. <br />
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But what if <a href="http://conversableeconomist.blogspot.com.es/2013/12/secular-stagnation-back-to-alvin-hanson.html">Alvin Hansen was right</a>, and in economies suffering from structurally weak consumer demand linked to ongoing demographic dynamics (and not simply a balance sheet recession) the principal determinant of productive investment decisions is not the cost of capital but corporate profitability and the anticipated size of the future market? In this case even success on the inflation expectations front would probably not deliver the expected recovery.<br />
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And there are downside costs. While financial markets boom, the living standards of the majority of Japanese families continues to fall as real wages drop month after month. It's hard to see consumption booming in this case. Then there is the debt: gross government debt current stands at around 245% of GDP.<br />
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It is often argued that in a country running a current account surplus and using its own currency such debt doesn't represent any special problem. I for one remain unconvinced that this is the case. This debt level, among other issues arising, effectively rules out any eventual "normalization" in interest rates since the servicing burden on the government would just be too high. But then - as some argue - this may now be old hat, since the Wicksellian natural rate of interest in Japan <a href="http://conversableeconomist.blogspot.com.es/2013/12/secular-stagnation-back-to-alvin-hanson.html">may have turned permanently negative</a>. If this is the case, however, why try formulate policy on neo-classical lines working towards a "classic" recovery? A recovery which may never come. If the natural rate is permanently negative we are hardly standing on the ground over which the traditional liquidity trap theory was built.<br />
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But it isn't only me who has doubts. Multilateral institutions like the IMF and the OECD also do. That is why they have been conducting debt sustainability analyses, and arguing for the consumer tax hike. Naturally proponents of <a href="http://www.nytimes.com/2014/03/21/opinion/krugman-the-timidity-trap.html">the timidity trap</a> suggest that such moves to bring Japanese government debt under control is a mistaken sequencing of priorities. First get sustainable inflation going, then get a self-perpetuating recovery, then address the debt the argument goes. But doesn't this beg the question of whether the objective is, in fact, attainable.<br />
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The late Karl Popper started to think about what distinguishes science from other social practices by confronting the apparent "irrefutability" of ideological systems like marxism or psychoanalysis. The problem with such world views is that they never seem to be testable, there is never any clearly identifiable fact "in the world" which can refute them. The "timidity trap" argument gives me a horrible deja vu feeling in this sense. Each time things don't work out as planned what Mr Abe and Mr Kuroda have to do is more of the same, no matter if you blow Japan clean out of the water, since the only reason the recommended recipe hasn't worked to date is that the balance sheet expansion and the associated stimulus haven't been big enough. I think it is time Paul came of age intellectually speaking and started to identify for us some concrete indicators which could prove his hypothesis wrong if they moved in the expected direction without producing the expected result, and stop telling us repeatedly that he has normally been right. <br />
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What if the Japanese economy simply can't sustain the desired inflation anymore, what if the historical epoch during which that expectation was feasible is now over? Obviously it isn't difficult to generate a certain amount of consumer price inflation if you raise consumer taxes, and again you can also get it if you devalue your currency, and keep doing so. But as we are now seeing, you do need to keep repeating the moves. There doesn't seem an underlying mechanism there waiting to be kick-satrted.<br />
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Without more tax hikes last April's increase will simply drop out of the inflation data by the time we reach next spring, and absent the implementation of the Abenomics 2.0 yen devaluation the currency-depreciation-induced inflation was already dropping out. The first round of Abenomics took the yen from 75 to 100 to the USD, the current bout has now taken it to around 115, but to keep injecting inflation in this way Kuroda would have to keep increasing the rate of balance sheet expansion on an annual basis and the yen would have to keep falling to lower and lower levels.<br />
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In a globalized economy currency depreciation is a zero sum game. One man's inflation is another's deflation. The so-called "<a href="http://larseosvensson.se/papers/grahamnt/">foolproof path</a>" is only really effective in the case on a single economy (or currency area) but not in the face of a generalised problem. Under current circumstances those whose currencies are forced upwards simply import the deflation/disinflation that is being exported by the the devaluers and on and on we go.<br />
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Paul Krugman has been pretty vocal in decrying those who have seen inflation where it wasn't, but what if he himself is falling foul of his own trial-by-fire in seeing inflation where it isn't in Japan inflation expectations? What if the drop in Japanese trend growth is long term and continuing, then why should we really expect the Abenomics experiment to work?<br />
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As Gavyn Davies pointed out <a href="http://blogs.ft.com/gavyndavies/2014/10/26/is-economic-growth-permanently-lower/">in a recent FT blog post</a>, over the years growth expectations for developed economies have persistently turned out to be too high. Three of Davies' colleagues at the research firm Fulcrum <a href="https://www.fulcrumasset.com/assets/Document/FulcrumResearchFollowingtheTrend.pdf?1414160940">have examined the behaviour of long run GDP growth in advanced economies</a>, and using customized versions of dynamic factor models they have produced a set of real time estimates of long run GDP growth rates. <br />
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On analyzing their results they found an extremely persistent slowdown in long run growth rates for the G7 as a whole. More surprisingly perhaps, it looks like this slowdown has been ongoing since the 1970s, and is not just a sudden decline after 2008. Averaged across the G7, they traced the slowdown to trend declines in both population growth and labour productivity growth, with the combined impact being a halving in long run GDP growth trends from over 4 per cent in 1970 to just 2 per cent now. <br />
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As they also state, the aggregate G7 result is a composite of widely differing trends at the
individual country level. As can be seen from the chart below, the Japanese case is a particularly clear one (the blue lines mark one and two standard error bands).<br />
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As it happens, Gavyn Davies' post produced a particularly poignant and cutting response from Paul Krugman - <a href="http://krugman.blogs.nytimes.com/2014/10/27/what-secular-stagnation-isnt/">What secular stagnation isn't</a> - in which he argues that secular stagnation "<i>is not the same thing as the argument..... that the growth of economic potential is slowing</i>". He suggests that this <i>"is a really important distinction, because secular stagnation and a supply-side growth slowdown have completely different policy implications.</i>"<br />
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But this attempt at making a supply-side/demand-side distinction is a strange one, not only because - as <a href="http://marginalrevolution.com/marginalrevolution/2014/10/in-the-medium-run-supply-and-demand-side-stagnation-stories-are-very-similar.html">Marginal Revolution's Tyler Cowan coherently argues</a> - in the medium to long run supply-side and demand-side are deeply interconnected. It is also confusing because Paul himself has spoken of the Japan problem being one of the country suffering from a <a href="http://www.bloomberg.com/news/2013-02-05/krugman-sees-japan-s-shrinking-population-as-crimping-growth.html">"shortage of Japanese"</a>, a supply side problem if ever there was one. I would say it should be obvious on simply a common sense level that having a smaller working age population restricts both potential growth AND aggregate demand. Krugman however doesn't see things this way, and argues that:<br />
<blockquote class="tr_bq">
<i>"If labor force growth and productivity growth are falling, the indicated response is (a) see if there are ways to increase efficiency and (b) if there aren’t, live within your reduced means. A growth slowdown from the supply side is, roughly speaking, a reason to look favorably on structural reform and austerity."</i></blockquote>
That seems clear enough, doesn't it? If Japan's potential workforce is declining and productivity deteriorating due to an increasingly aged workforce then, roughly speaking, we should favour structural reforms and austerity (Mrs Merkel, are you listening?)<br />
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But then comes the catch.<br />
<blockquote class="tr_bq">
"<i>But if" - on the other hand - "we have a persistent shortfall in demand, what we need is measures to boost spending — higher inflation, maybe sustained spending on public works (and less concern about debt because interest rates will be low for a long time).</i>"</blockquote>
Perhaps the key word here is "shortfall". Shortfall relative to what? To what it was in the past, or to potential demand now. If it is the latter, then there must be something at work now, something beyond simple demographic and productivity dynamics (and the mountain of government debt), that is holding growth back. If that is the case, it would be interesting to know what that "something" was. Since otherwise Japan seems to be heading deeper and deeper into a very risky experiment based on a misunderstanding about what the problem facing the country actually is. <br />
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The above analysis is based on arguments fleshed out in much more detail in my "mini book" the A B E of Economics.<br />
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The book is available with Amazon as an e-book. <a href="http://www.amazon.co.uk/gp/product/B00L4KTLDM?*Version*=1&*entries*=0">It can be found here</a>.
You don't need to buy a Kindle to read this book. You can <a href="http://www.amazon.com/gp/feature.html/ref=kcp_pc_ln_ar?docId=1000426311">download a free app from Amazon</a>.<br />
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Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-56133864017186377272014-10-20T09:46:00.001-07:002014-10-24T05:07:51.779-07:00Does The Secular Stagnation Theory Have Any Sort of Validity?In a number of blog-posts (<a href="http://edwardhughtoo.blogspot.com.es/2014/06/secular-stagnation-part-1-paul-krugmans.html">Paul Krugman's Bicycling Problem</a>, <a href="http://edwardhughtoo.blogspot.com.es/2014/06/secular-stagnation-part-ii-on-bubble.html">On Bubble Business Bound</a>, <a href="http://edwardhughtoo.blogspot.com.es/2014/09/secular-stagnation-part-iii.html">The Expectations Fairy</a>) I have examined some of the implications of the theory of secular stagnation. But I haven't up to now argued why I think the hypothesis that Japan and some parts of Europe are suffering from some kind of secular stagnation could well be a valid one.<br />
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Strangely, while I would suggest the most obviously affected countries are those mentioned above, most of the debate has centered around the US economy. Since it is not at all clear that the US economy is actually suffering from either a liquidity trap or secular stagnation at this point, this has lead many to question whether the idea might not be ill-founded. The Economist, for example, in a revue article (<a href="http://www.economist.com/blogs/freeexchange/2014/08/secular-stagnation">Fad or Fact</a>) of Teulings and Baldwin's <a href="http://www.voxeu.org/article/secular-stagnation-facts-causes-and-cures-new-vox-ebook">Vox e-book on the topic</a> conclude the concept "remains a baggy one", one which is "arguably too capacious for its own good". <br />
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Viewed in this light the concept does at times appear vague, and lacking in clear definition. In part this is because Alvin Hansen's original idea was made up of two components, a technological and a demographic one. Naturally if there is a slowdown in the rate of impact of technological innovation then this would be felt equally across those economies which are operating near the technological frontier. But the phenomenon which is being described today as secular stagnation isn't being witnessed equally across all those countries. Economies in both the UK and the US appear to have responded differently to those in Sweden, the Euro Area and Japan, a phenomenon which is obvious to the theory's critics. Thus the Economist author goes on to argue, "it is hard to avoid the conclusion that many of the euro area’s difficulties result from a dysfunctional monetary union rather than a susceptibility to secular stagnation." And it would be hard to disagree with the writer on this count, except... except ....except that there is the awkward little case of what is happening to Japan, a country which as it happens doesn't use the Euro, or in Europe itself to countries like the Czech Republic, Sweden or Hungary that don't use it either.<br />
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Which brings us nearer to the demographic part of the argument. Is there any pattern emerging in the way symptoms which look like those which would be presented in cases suffering from secular stagnation are showing up? Well, I would argue there is. I think it is generally accepted that the first affected country was Japan. It was in Japan that a slowdown in GDP growth (not GDP per capita growth) was first noted.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgOeg_hKpoaniDnCfrIQpVnhywCN6k-9bnPbveB6_aOckIhrMzbVZuEszlt0R2jcRfWaPSlHOiqW8F4yshhQRniikoveWKJrRHGojh7jHj-Swj6dyU5gWei1ypB__5t6hAydENfTOHAntAY/s1600/gdp+four.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgOeg_hKpoaniDnCfrIQpVnhywCN6k-9bnPbveB6_aOckIhrMzbVZuEszlt0R2jcRfWaPSlHOiqW8F4yshhQRniikoveWKJrRHGojh7jHj-Swj6dyU5gWei1ypB__5t6hAydENfTOHAntAY/s1600/gdp+four.png" height="165" width="320" /></a></div>
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Japan was also the first country were working age population started to turn negative (in 1997) and where the correlation between declining growth momentum in this group and creeping deflation first started to be noticed.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhEGr8pFPrSdO7BKMtMxzAhMIq2HN66tUQQDRDmxfXk4eHj9Usqp-93V7BAhjySJAWSTCXCIWniu13tW4KQowkOPt0mNePR_rX_IhWCcSmVrdEr3WJYb6qPRtEhbPDAeKRjtjVzzot-pxAE/s1600/Japan+Population+and+Inflation.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhEGr8pFPrSdO7BKMtMxzAhMIq2HN66tUQQDRDmxfXk4eHj9Usqp-93V7BAhjySJAWSTCXCIWniu13tW4KQowkOPt0mNePR_rX_IhWCcSmVrdEr3WJYb6qPRtEhbPDAeKRjtjVzzot-pxAE/s1600/Japan+Population+and+Inflation.png" height="320" width="317" /></a></div>
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Here's what movements in EU working age population look like.<br />
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And here's why I don't think considerations of demography can really justify the secular stagnation thesis in the United States context at the present time.<br />
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EU working age populations started to decline in the years between 2009 and 2012. They will now continue to decline for many years to come. In the United States however, while the rate of growth in this population segment has slowed in recent years, it is about to start accelerating again. As Calculated Risk's Bill McBride <a href="http://www.calculatedriskblog.com/2014/06/the-future-is-still-bright.html">pointed out</a>, the US Census Bureau now reports that Baby Boomers aren't the largest US cohort anymore, and that the prime working-age force is expected to start growing again in a few years. In other words, in terms of the demographic outlook, the dynamic points to stronger, rather than weaker, economic growth. By 2020, eight of the top ten largest cohorts (five year age groups) will be under 40, and by 2030 the top 11 cohorts will be the youngest 11 cohorts. (see the marvelous animation Bill has at the end of his post).<br />
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<b>Not All Europe Is The Same</b><br />
<br />
Naturally, demographic dynamics are not the same in every country across Europe. The two oldest countries on the planet are Japan and Germany with median population ages of around 46. Then comes Italy with with one of 45. I have <a href="http://edwardhughtoo.blogspot.com.es/2014/10/eurocrisis-round-two-blame-germans.html">recently written</a> about the possibility Germany is bogged down in some kind of secular stagnation process. The Economist writer argues that what Europe's economies need are structural reforms, but it isn't clear if he also thinks Germany needs another swathe of these. Long term growth is low in Germany, and inflation pressures are weak. It is not clear, however, that Germany is stuck in any kind of any kind of balance-sheet-recession-type liquidity trap. Loan growth is low, but this may well be a function of the age structure of the population. <br />
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It's no big secret really that Italy is suffering long term growth stagnation (which many, like the Economist and Beppe Grillo simply attribute to Euro membership).<br />
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And Italy has recently begun to have negative inflation levels.<br />
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<br />
Next on the list come countries like Austria (median age, 44), Finland (43,2), The Netherlands (42.1), Switzerland (42) and Sweden (41.2). It is striking that both Finland and The Netherlands have recently been suffering from very weak growth and almost constant recessions, while Sweden and Switzerland have an ongoing problem with a deflation threat.<br />
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If we fan out a bit, and move over to Eastern Europe, where working age populations are almost universally falling, the sharp fall in growth rates between the years before and the years after the crisis is also pretty noteworthy. <br />
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Before the crisis annual growth rates were in the 4% to 6% range, now they are in the 1% to 2% range, and these are all emerging economies with levels of GDP per capital well below the EU average, countries who should in theory be experiencing strong "catch up" growth.<br />
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At the same time inflation, which was previously a significant problem, has all but disappeared and in fact deflation risk is pretty general across the region. Normally CEE countries have median ages of around 41, much older than say Ireland with a median age of 35.7, or the United States with one of 37.6.<br />
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So we seem to be observing the following pattern: working age population growth approaches zero and starts to turn negative, growth slumps to about 1% a year and falling, and inflation weakens to the point of becoming deflation. If this rough correlation is reasonably valid the next countries where we see secular stagnation setting in are South Korea and China, since working age populations are now in the process of turning there too.<br />
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<span style="font-size: large;"><b>A Simple Mechanism</b></span><br />
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So how do secular stagnation work? What's the mechanism? Well so far we have been offered two, one <a href="http://krugman.blogs.nytimes.com/2014/05/19/demography-and-the-bicycle-effect/">from Paul Krugman</a>.<br />
<br />
<blockquote class="tr_bq">
"<i>To have more or less full employment, we need sufficient spending to make use of the economy’s potential. But one important component of spending, investment, is subject to the accelerator effect: the demand for new capital depends on the economy’s rate of growth, rather than the current level of output. So if growth slows due to a falloff in population growth, investment demand falls — potentially pushing the economy into a semi-permanent slump</i>."</blockquote>
A slowdown in the rate of increase in domestic demand leads to a slowdown in investment, and this double slowdown pushes the economy into a dependence on exports and very weak GDP growth. The first place this "underinvestment" phenomenon showed up was in Japan. <br />
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<br />
Then we have seen it in Germany.<br />
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And now the "German" phenomenon has spread to the rest of Europe.<br />
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The second pathway through which demographically driven secular stagnation operates was described by a group of IMF economists in a recent research paper: "<a href="https://www.imf.org/external/pubs/cat/longres.aspx?sk=41812.0">Is Japan’s Population Aging Deflationary?</a>" Lower demand from older populations (less credit growth) leads to oversupply and deflationary pressure. The first part of the paper abstract runs as follows:<br />
<br />
"Japan has the most rapidly aging population in the world. This affects growth and fiscal sustainability, but the potential impact on inflation has been studied less. We use the IMF’s Global Integrated Fiscal and Monetary Model (GIMF) and find substantial deflationary pressures from aging, mainly from declining growth and falling land prices. Dissaving by the elderly makes matters worse as it leads to real exchange rate appreciation from the repatriation of foreign assets. The deflationary effects from aging are magnified by the large fiscal consolidation need."<br />
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So while there is no definitive answer at this point to the question whether or not what we are seeing is a creeping process of secular stagnation which will gradually spread from one economy to another as the respective working age populations start to contract, there is strong prima facie evidence that there may be, that the theory is worth examining and that the hypothesis should continue to be tested.<br />
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<br />
<b> Postscript</b><br />
<br />
The above arguments about why the Euro Area countries may have entered some sort of state of secular stagnation are developed in detail and at far greater length in my new book "<a href="http://www.amazon.com/The-Euro-Crisis-Really-Over/dp/1502343436/ref=sr_1_2?ie=UTF8&qid=1410776947&sr=8-2&keywords=edward+hugh"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/Euro-Crisis-Really-Over-Whatever-ebook/dp/B00NKA6PN8/ref=sr_1_2?s=digital-text&ie=UTF8&qid=1410812161&sr=1-2&keywords=edward+hugh">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-81014284712953753642014-10-18T03:48:00.000-07:002014-10-18T03:48:21.747-07:00Open Letter to the Economist on Catalonia - J'accuse<b>Those who have interest in neither Catalonia nor the issue of journalistic standards will probably find this posting long, tedious, and not especially interesting. Perhaps you might like to stop at this point. Those of you who are interested in one or other of these, well, I invite you to read on..... </b><br />
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<span style="font-size: large;"><b> To The Editors Of The Economist</b></span><br />
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I am writing this missive addressed to you as I am outraged, nay scandalized, by the level of your reporting on the Catalan question. The source of my discontent are two recent pieces - both signed by one GT - the first of which appeared on the Charlemagne Blog (<a href="http://www.economist.com/blogs/charlemagne/2014/09/catalonias-referendum" target="_blank">Getting to “sí”</a>, 19 September 2014), while the second was published under the rubric The Economist Explains (<a href="http://www.economist.com/blogs/charlemagne/2014/09/catalonias-referendum" target="_blank">Catalonia’s independence movement</a>,14 October 2014.) <br />
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Of the two, I consider the second much more reproachable since it purports to be an informative document, and not a mere opinion piece. My issue with your journalist is not his opinion - to which any journalist is entitled - but that he attempts to pass off opinion as fact. My view is the that the level of journalism being demonstrated is not what you should be seeking in a publication with your high level of international prestige.<br />
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At the end of the day, of course, whether this is the case or not is an editorial decision on your part. I fully understand why the Economist originally took the decision to publish non-editorial unsigned articles, but in the modern age I think this be a double edged sword as it leads to confusion about what is an Op-ed and what isn't. Personally I think the practice is now more trouble than it's worth, but again that's for you to decide.<br />
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In order to try and demonstrate my case I have gone to the rather tedious lengths of re-reading the two offending articles and identifying what I consider to be factual inaccuracies (see below). <br />
<br />
In a personal mail addressed to me, GT says he admires President Mas, and even describes the new Catalan "consulta" as a brilliant move. It is a pity he couldn't have brought himself to express such opinions in the articles. My reproach is not related to any one phrase or statement, but to a long history of the same over many years.<br />
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My feeling is that in the present context, and with so much for the whole of Europe at stake here in Spain both politically and economically in the coming years, what GT does verges on the irresponsible, especially in an article with the header The Economist Explains. Curiously for an article with such ambitions it is striking that the ANC (Assemblea Nacional Catalana) which is the key civil society organisation promoting the independence drive) doesn't get even a mention.<br />
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In his mail GT tells me he is critical of Mr Rajoy, but frankly in his last two pieces this criticism is hardly noticeable. My "j'accuse" is based not on this factual inaccuracy (or superficial assessment) or that one, but on the fact that quantity eventually becomes quality. Despite claiming to admire Artur Mas the sum total of GT's "comedy of errors" makes the Catalan President look more like a character from Hotel Faulty, a sort of mediocre, run of the mill politician who was busying himself "ploughing another furrow" when the indy movement snuck up on him and forced him to try to "regain control". He is seen as a politician who is almost permanently under threat from the "Manuel" (or Sancho Panza) type character (Oriol Junqueras, leader of the openly separatist ERC - "my name is Oriol and I come from Barcelona") who is constantly threatening to wreak havoc with his best laid plans. Funnily enough there is a popular weekly satire programme on TV here which does something similar, but that programme, evidently, is just that, satire.<br />
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<span style="font-size: large;"><b>Getting to “sí</b>”</span><br />
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<b>"On Friday Catalonia's parliament passed a so-called “law of consultations”, with a view to allowing Mr Mas to call a referendum on November 9."</b><br />
<br />
This - that what the Catalan Parliament intended to enable under the "law of consultations" was the holding of a referendum - is just plain wrong. The law enables only popular consultations, and this was always its intention. Whether the vote called under the initial decree issued under the law was in fact a referendum is disputed, and vigorously so. The Catalan side argue it was an opinion-sounding vote, with no legal consequences, and have appealed to the Constitutional Court on just these grounds, against the Spanish government submission that it is de facto a referendum. The court has not yet ruled on this issue. When it does it is quite possible that it rule the law as such (possibly with some amendments) falls within the competences assigned to the Catalan Parliament under its charter, but that the question that was to be put is not covered by the law since it may be considered to constitute a referendum. But since the "with a view to" words constitute an opinion about what was in the heads of the members of the Catalan parliament at the time of voting, all I can say is that there is no evidence to support this view.<br />
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Now, there is no harm in putting both sides of the argument, but I do think it is incumbent to put BOTH sides of the case. Also, it would be quite legitimate for GT to take the view it was a referendum by another name, but I do think he should make clear that this is his opinion. If you don't mention that the Catalans considered their attempted vote a "consulta" not a referendum - one without any evident legal consequences - then it's hard to make sense of everything that has taken place subsequent to the suspension, and especially it is difficult to explain how the new vote that has been called for the same day with the same questions differs from the suspended one. Apart from the legal framework in which it is to take place, to all appearances it doesn't.<br />
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<b>"If Mr Mas obeys and cancels the referendum, his minority nationalist government, propped up by the separatist Catalan Republican Left (ERC), may fall."</b><br />
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Again, GT refers to "referendum" as if it was clear that this is what it would have been. As can be seen, President Mas cancelled the order authorizing the vote but his government didn't fall. It was never going to, and I think only people in Madrid ever believed this to be a possibility. In order to understand why this was always going to be a highly improbable outcome maybe you do need to be familiar with some very simple "game theory". <br />
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<b>"In the most extreme one, Mr Mas could stage an illegal referendum, with police moving in to remove urns and Madrid suspending the Catalan regional government's right to rule."</b><br />
<br />
Well let's imagine that President Mas was to call an illegal "referendum" (not totally ruled out, but unlikely since he has continually insisted on his desire to work within the existing legal framework, or at least within his legal advisers' interpretation of it). The scenario GT depicts leaves me with one very basic question: where would these police come from? The number of Guardia Civil and Policia Nacional in Catalonia is very, very small. The vast majority of police in Catalonia are either local (municipal) police or belong to the body known as the Mossos de Esquadra, a Catalan police force under orders to the Generalitat de Catalunya. So this was a silly, unrealistic scenario. If the government in Madrid do move against the Catalan government, in my opinion, it will be through the courts and through cutting-off finances. Maybe even trying to suspend the Statute of Autonomy under which the Catalan Parliament operates.However legal experts here question whether - despite the threats to do so that have on occasion been made - they in fact have the power to do this under the terms of the Spanish constitution. So it is possible that any hypothetical suspension of the "right to rule" may in practical terms need to involve some sort of suspension of the very constitution Mariano Rajoy declares he is determined to defend. That would be ironical, wouldn't it?<br />
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<b>"Catalonia cannot negotiate to win more such powers from Madrid, for the simple reason that it already has them."</b><br />
<br />
Well, again this is just an empty silly argument, since it is obvious there will eventually - as in the Scottish case - be third way proposals (maybe even a West Lothian question) as GT admit in his second article. There is no theoretical limit to the amount of devolution that can take place within a federal state. Especially if we start talking here about bi-lateral federalism for Catalonia. Again, he later points out, maybe many Catalans would vote for a new type of arrangement along these lines, and indeed this is why the consultation question is framed in two parts, so people can vote for the option of a (federated) Catalan state within Spain. If GT were to argue that maybe Artur Mas is ambiguous on this point, I would say that view is legitimate. As a democrat I suspect President Mas would go along with what he felt a majority of Catalans wanted. On the other hand I'm not sure I've seen any reference to the fact that there are to be two questions, or any analysis of the significance of this fact in any of his published material.<br />
<br />
<span style="font-size: large;">Catalonia’s independence movement</span><br />
<br />
<b>"The regional government of Catalonia ..... was planning to hold a non-binding referendum on independence on November 9th."</b><br />
<br />
Well again, this is a one side way of putting it (see above) the continual repetition of which brings into question GT's independence on the matter.<br />
<br />
<b>"On October 14th the Catalan prime minister, Artur Mas, announced that some form of "consultation", involving "ballots and ballot boxes", would go ahead anyway on November 9th, regardless of the Court's decision."</b><br />
<br />
Well exactly, this is simply the earlier consultation without any decree behind it, since President Mas is gambling that without a decree the Madrid government can't go to the constitutional court to get a decree which doesn't exist suspended. As GT says in his mail to me, it's a brilliant stroke. Since the Catalan Parliament never considered the 9N vote a referendum, neither version could be considered to have legal consequences, the only force they can have is political, in demonstrating people's opinions. At the international level these political effects should not be underestimated, hence, I venture to suggest, Mariano Rajoy's desire that it not take place.<br />
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<b>"The two motors of the new wave of separatism are Spain's economic woes and a 2010 Constitutional Court decision to strike out part of a renewed charter of self-government that had been approved at referendum."</b><br />
<br />
This is undoubtedly true, but maybe it would have been helpful to have mentioned WHICH part of the charter was struck down - the declaration that Catalonia is a nation. This is especially relevant since it is at the heart of the current issue, and also in the light of his next comment. The fact that this little word was struck out following an appeal from the Partido Popular to the constitutional court after a "popular participation" protest which involved the collection of a large number of signatures is possibly also relevant. President Mas is simply repeating this performance in reverse.<br />
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<b>"Many Catalans, who speak their own language as well as Spanish, believe their taxes pay for poor, lazy southerners to live off government hand-outs."</b>
<br />
<br />
As well as the fact that they speak that language maybe he could have said a bit more, especially about how the Catalans now feel their language - which was of course banned during the Franco years - is once more under threat. Recent developments in Valencia, the Balearic Islands, Aragon (where there are significant Catalan speaking communities) are seen as a clear sign of an intention to limit use of and familiarity with the language. The most recent Spanish educational reform which attempts to influence the quantity of teaching in Catalan in Catalan schools is also highly contentious and important in understanding the current strength of feeling.<br />
<br />
In addition, the second part of his sentence is little better than an Andy Capp type caricature. The quantifier "many" often hides a multitude of sins. Many Germans think something of the kind about Spaniards in general, but I doubt it is a majority. The same is true of Catalans. What Catalans want is to be able to decide what to do with their own resources.<br />
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They also want to be recognized as a nation and not continually told there is only one nation - the Spanish one - of which (under the terms of the constitution) they are all compelled to form part (whether they like it or not). <br />
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<b>"Mr Mas has been caught unprepared by this wave of separatist enthusiasm. He responded first by demanding new tax-raising powers from Madrid."</b><br />
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Well, this is one of the issues where I feel GT has things totally back to front. Artur Mas, like the ANC - who he somehow manages to avoid mentioning even once in what is supposed to be a background information article - and everyone else, was as he says surprised by the *size* of the 2012 demonstration, and this undoubtedly encouraged him to move forward more quickly with a project he was already working on - the Catalan "national transition" - and recognise the leaders of ANC and Omnium Cultural as legitimate leaders of Catalan civil society.<br />
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No man is an island, and President Mas himself had been evolving as part of this growing separatist feeling since 2006. It was around that time he first started talking about moving towards a "national transition". This transition was already conceptualized as creating the institutions necessary to move towards independence. A declaration of some kind of statehood was always going to be the end point. So he was himself fanning the flames. He was not simply a late opportunistic add-on to the developing idea that Catalonia had gone as far as it could within the terms of the 1978 constitution.<br />
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On the isssue of the tax proposal GT is just plain wrong: President Mas's tax proposal was not a hasty response to the arrival of a wave of separatism. It was an idea he had been working on all through his years in opposition. Certainly he seems to have been quite happy when Rajoy (perhaps foolishly) greeted this proposal with an outright "no", since this meant he could then move on to the next stage in the project. I think the size of the separatist movement lead him to accelerate his plans, and shorten the time scale of the "national transition".That is all.<br />
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<b>"When they [the tax powers] were refused he called a referendum, knowing it was likely to be banned. It has not been enough to convince voters:"</b><br />
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What is the insinuation behind "knowing it was likely to be banned"? That it was all part of a carefully calculated plan - just another step towards the "elections as a referendum move"? Mas as Machiavelli? Or is GT suggesting that he was simply trying to throw sand in the voters eyes, to stall for time. The general gist of his argument leads towards the latter conclusion, so if he wanted to make the former point may I suggest that there are better ways of doing so. Like saying "this was also brilliant".<br />
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<b>"Spain's conservative prime minister, Mariano Rajoy of the Popular Party (PP), has refused to call a referendum, which has only stoked support for one"</b><br />
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Mariano Rajoy, to my knowledge, has not been asked to call a referendum at any point, so he has not refused to call one. The Catalan parliament in the spring of this year asked the Madrid one to authorize them to hold one - as had happened with the earlier referendum which was held over the new charter in 2006 - but this time the Madrid parliament refused. Once a referendum became impossible the Catalan parliament decided to go for a "popular consultation" - the legal aspects of the two - as I keep saying - are rather different. I suggest that the fact that GT didn't distinguish between referendum and "consulta" in the first instance leads to this kind of confusion. maybe he himself was confused.<br />
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<b>"It [the Spanish government] also refuses to countenance the opposition Socialist Party's “third way” approach, which would involve constitutional reform to give Catalonia still more power and make Spain more federal. Polls show such reforms could bring support for independence below 50%."</b><br />
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See my point above, this is the reason more autonomy could clearly be offered, as happened in the Scottish case. And is indeed one of the few occasions on which GT criticizes Mariano Rajoy.<br />
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<b>"Mr Mas's pseudo-referendum is still due to go ahead on November 9th, though it will have no legal consequence."</b><br />
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Well, we're back to the same old issue. What would have been the legal consequence of the suspended vote? None. What will be the legal consequence of the new vote? None. What's the real difference? None.<br />
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Essentially the two votes are one and the same - same questions, same date, same ballot papers, same ballot boxes - and serve the same purpose, to find out what those who want to vote think. "No" supporters would not vote in either case, so we are only talking about getting a rough idea of who would vote "yes-yes" in a full referendum. <br />
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The use of the expression "pseudo referendum" irks somewhat here, since it sounds remarkably like the Catalan PP leader Alicia Sanchez Camacho's disparaging "refèrendum de costellada" (Sunday afternoon barbeque referendum). Pseudo (unlike say surrogate, or placebo) is normally used very negatively in English.<br />
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<b>"The “no” side has either refused to engage or, where it has spoken up, been drowned out."</b><br />
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I dispute this. Both parts. Plenty of people have come to Catalonia from Madrid and other areas of Spain to argue in favour of "no". Both putting the constitutional case for "no" vote (rather than "no" in the vote) and arguing Catalonia is better off inside Spain. What hasn't existed is a "better together" campaign since there has been no third way offer to campaign for, and an assumption that there will be no vote. I also see no evidence of people being "drowned out". Plenty went to the Plaça Catalunya on 12 October (maybe 50,000) to show their support for staying in Spain. If people think that more than a small minority actively oppose independence, then the best way to find out is to have a real referendum and see. Constant insinuation achieves nothing.<br />
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GT also misses the key point about the elections as referendum proposal: this - in President Mas's opinion - is the only way to get the "no" side to actually campaign and vote - a key point in his international legitimization strategy.<br />
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<b>"Mr Mas may now be forced to call early elections."</b><br />
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President Mas is not going to be FORCED to call early elections, as GT obviously knew since he explained to me he watched a video of the relevant press conference. The Catalan president is actively promoting them and sees these as the best way forward. In fact he is struggling with the other parties to get them to accept this idea and join a common list.<br />
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<b>"The likely winner would be the radical ERC, which would lead a regional government encouraging civil disobedience, if the party sticks to its current position."
</b><br />
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So again no, the likely winner wouldn't be ERC but the "yes-yes" vote. Mas has said he won't call early elections unless a common platform is agreed to. His mandate extends to November 2016. He doesn't even need the support of any other party to pass the 2015 budget since he can simply extend the validity of this year's in the same way he did this in 2011 with the 2010 ones he inherited when he came to office.<br />
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You could, like Oriol Junqueras suggest he has electoral purposes in taking this stance. That is a matter of opinion. Think again about game theory and the prisoner's dilemma. The outcome of those elections wouldn't, in his opinion, be an immediate UDI, but hey, guess what, Artur Mas's blessed national transition - which it is suggested would last 18 months - during which time an attempt would be made to create the institutional infrastructure necessary for UDI. In fact he has has an advisory body on the national transition at work since the November 2012 elections preparing all the documentation and strategy precisely with this in mind. <br />
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Naturally Madrid would probably not stand idly by - see comments above - but that is not what we are talking about here.<br />
<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-29791396399120274302014-10-13T10:56:00.000-07:002014-10-14T04:33:54.142-07:00Eurocrisis Round Two, Blame the Germans Edition"What strikes me, also, is the extent of intellectual confusion that remains." - Paul Krugman, <a href="http://krugman.blogs.nytimes.com/2014/10/11/europanic-2-0/">Europanic 2.0</a><br />
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“The problem is that Germany has continued to maintain highly competitive labor costs and run huge surpluses since the bubble burst — and that in a depressed world economy, this makes Germany a significant part of the problem.” – Paul Krugman, <a href="http://krugman.blogs.nytimes.com/2013/11/03/german-surpluses-this-time-is-different/">German Surpluses: This Time Is Different</a> <br />
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According to one fairly widespread (and recently much in vogue) theory about the Euro crisis, Germany bears a large part of the responsibility for the current mess. The view is met with a variety of responses inside the country, ranging from horror to amazement. Naturally, if the argument were simply about the way Angela Merkel has handled the crisis – no Eurobonds, no debt forgiveness, systematic fiscal austerity – then possibly some of it could be understood. But no, things go beyond that, Germany has been too successful, too competitive, and this has presented a big problem for its partners who simply haven’t been able to keep up. <br />
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This deeper “German bad” argument can take a variety of forms. The country is said to be obsessed with austerity even though all its partners are struggling to find air, it is thought to be guilty of running excessively large current account surpluses, it is accused of not showing sufficient solidarity with its south European partners by being unwilling to run higher inflation: what is more it is said to have benefited from a kind of vendor financing procedure during the good years and then complaining when the customers can’t pay. The list is a long one. The UK economist Simon Wren-Lewis even accuses them of having attained their hegemonic status simply by <a href="http://mainlymacro.blogspot.com.es/2014/08/lessons-of-great-depression-for-eurozone.html">undercutting everyone else</a>.<br />
<blockquote class="tr_bq">
<i>“Within the Eurozone, we have a problem created by Germany undercutting pretty well every other economy in the 2000-2007 period. I am not suggesting this was a deliberate policy, but the consequences were not appreciated by any Eurozone government at the time.”</i> </blockquote>
The questionable status of this version of events was highlighted once more last weekend <a href="http://krugman.blogs.nytimes.com/2014/10/11/europanic-2-0/?_php=true&_type=blogs&_r=0">in a blog post</a> by Paul Krugman (who has been little short of prolific in his tirade against what he considers to be the bastion of theoretical stupidity in Berlin - <a href="http://krugman.blogs.nytimes.com/2013/11/01/the-harm-germany-does/?_r=2">The Harm Germany Does</a>, <a href="http://krugman.blogs.nytimes.com/2013/11/01/more-notes-on-germany/">More Notes On Germany</a>, <a href="http://krugman.blogs.nytimes.com/2013/11/02/sin-and-unsinn/">Sin and Unsinn</a>, <a href="http://krugman.blogs.nytimes.com/2013/11/02/france-1930-germany-2013/">France 1930, Germany 2013</a>, <a href="http://krugman.blogs.nytimes.com/2013/11/03/german-surpluses-this-time-is-different/">German Surpluses: This Time Is Differen</a>t, <a href="http://krugman.blogs.nytimes.com/2013/11/12/germanys-lack-of-reciprocity/?_r=0">Germany’s Lack of Reciprocity</a>, <a href="http://krugman.blogs.nytimes.com/2013/11/11/europes-macro-muddle-wonkish/">Europe’s Macro Muddle (Wonkish)</a>, <a href="http://krugman.blogs.nytimes.com/2014/08/29/germanys-sin/">Germany’s Sin</a> ). <br />
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Personally, I think that behind this whole approach there lies a major misunderstanding about just what is going on in Europe (dare I use the word "confusion"). Why is the Germany economy falling back towards a possible recession? Why does a country which recovered so rapidly from the global recession in need itself of stimulus? What we need to look at is why it is that Germany itself has problems. Why it looks so much like Japan, and not the extent which it could be blamed for the obvious economic problems in Italy and France. Instead of crying to the heavens about the country's current account surplus why don't we ask why domestic demand is so weak. Surely not because the country is living through a "balance sheet recession".<br />
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What worried me is that people are suggesting remedies - once which they admit might not even work - without getting to the heart of an adequate diagnosis. The nub of the problem is to be found in the following statement in <a href="http://krugman.blogs.nytimes.com/2014/10/11/europanic-2-0/?_php=true&_type=blogs&_r=0">PK's latest post</a>: <br />
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"<i>Draghi can try to get traction through quantitative easing, but it’s by no means clear that this could do the trick even under the best of circumstances — and in reality he faces severe political constraints on what he can do.</i>"<br />
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The argument we are being served up seems at best simplistic: Draghi is good, Schaüble is bad. That may be fine for those of you who like your world polarised in nice Manichean fashion, but would that things were so simple. I just spent a good deal of time writing a blogpost - <a href="http://edwardhughtoo.blogspot.com.es/2014/09/the-japanisation-of-europe.html">The Japanisation of Europe</a> - which tried to argue that Mario Draghi is understating the extent of the mess Europe is in, and detailing the shortcomings in his knowledge of what actually happened in Japan. I am no admirer of the intellectual corner Herr Schaüble finds himself in, but I can't help feeling there is a significant element of "good cop" , "bad cop" going on here, with everyone defending the script they've been allotted, still if you like your stories nice and simple.....<br />
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What worries me isn't the idealisation of Mario, nor the demonification of Wolfgang, no it isn't that at all, it's those five little words Krugman uses: "it's by no means clear". This vagueness worries me since it rings a bell in my head about a phrase he used on an earlier occassion: Japan's "economy won’t always be in a liquidity trap, or at least it might not always be there." (<a href="http://krugman.blogs.nytimes.com/2013/04/11/monetary-policy-in-a-liquidity-trap/?_php=true&_type=blogs&_r=0">Monetary Policy In a Liquidity Trap</a>). For someone who wants us to draw the conclusion that it's the other side who are confused this vagueness is a bit rich. Does the policy he is advocating work or doesn't it? I think the guinea pigs have the right to know before giving their permission to the experiment?<br />
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You see, it wouldn't be so bad if there were strong grounds for thinking that full blown QE might shock the Euro Area out of its secular stagnation, but as I've been arguing for some time now (see my <a href="http://edwardhughtoo.blogspot.com.es/2014/06/secular-stagnation-part-1-paul-krugmans.html">Paul Krugman's bicycling problem</a>) the logic of Paul's argument (that secular stagnation is ultimately the result of long term fertility trends, and the long term natural interest rate may well be permanently negative) leads to the opposite conclusion: that it probably won't. And <a href="http://edwardhughtoo.blogspot.com.es/2014/09/does-abenomics-work-doubts-grow.html">growing evidence</a> from the application of Abenomics in Japan seems to confirm that view. To quote Martin Wolf again, "you can't print babies".<br />
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There are lots of things wrong with the Euro Area and it's institutions, and much needs to be done, but sending 18 countries on an experiment with consequences that wouldn't be benign and might not work doesn't seem like exactly the best way forward if you're not sure about what you're doing.<br />
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<b>Not Simply An Export Model, Germany is the most Japanised of Europe's economies. </b><br />
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This whole “German Bad” approach is fundamentally flawed in my opinion, since while the crisis has revealed many failings in the south European economies – book cooking, corruption and conniving with money hungry developers, the presence of large and systematic extractive networks who were basically living off economic rents – the finger pointing towards their German counterparts smells all too much like saying something like “why did they have to be so good at selling their products.”<br />
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Simply cutting wages in the south isn't the answer (although carrying through a more serious internal devaluation involving reducing both prices and wages might be if you want to hold the Euro together). But neither is making Germany less competitive. <br />
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Even the idea that Germany has done better than its partners simply by driving down wages doesn’t fit the facts. According to Eurostat, average hourly wages in Germany in 2013 were 31.3 Euros. In Greece they were 13.6 Euros (and 16.7 Euros in 2008), in Spain they were 21.1Euros (and 19.4 Euros in 2008), while in Italy they were 28.1 Euros (and 25.2 Euros in 2008). In fact Germany came 8th in the Euro 18 league as far as hourly salaries goes. The conclusion you should draw from this data is that Germany’s unit labour costs are low not because Germans aren’t paid much, but because they are very productive, and at the end of the day, despite all the bleating about the current account this is the model other members of the Euro Area (including France) not only need to but are compelled to follow: high pay and high productivity. Indeed Paul Krugman more or less admits this reality:<br />
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<i>“So while it’s impressive that Germany can run a surplus despite quite high labor costs, and that’s a testimony to the quality of its stuff, ultimately the surplus reflects high savings relative to investment.”</i> <br />
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High savings relative to investment is exactly the argument Krugman uses to explain demographically driven secular stagnation: there is insufficient capex as a result of weaker domestic demand. So German savings are a symptom of something, and that something needs adequate diagnosis.<br />
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Even a cursory examination of German growth rates – the trend is now down to around 1% - suggests that all is far from well, as do the constant relapses back towards recession. The country simply looks good because all its partners are doing so badly.<br />
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<br />
What southern Europe needs is a revolution in the mindset and more “better quality” stuff, and no amount of blaming Germany for the situation can get over that. The extractive networks who hold back growth need reforming out of existence.<br />
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At the same time the under-investment over-saving phenomenon that characterizes Germany bears a remarkable similarity to what has been happening in Japan, with the strange difference that these days Japan is normally sympathized with and not blamed for all the world’s ills. <br />
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The Japanisation of Europe is most evident in the creeping stagnation in the so called core, and above all in Germany. Germany could probably help more with its short term fiscal stance, as Mario Draghi is arguing, if the others had a clearer plan, but at the moment the reform impetus in countries like Spain - unemployment still around 27%, a 3% fiscal deficit in Germany won't shave much off that - is waning severely. Shock measures to address this "unacceptable" unemployment is being neither contemplated or nor even discussed.<br />
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But the idea that Germany is stagnating on a temporary basis is absurd. It has been sliding to where it is now for over a decade, and short term stimulus won't be any kind of game changer. Nor are structural reforms likely to make that great a difference, the country has already done a lot of those. They slowed the process down - which is what structural reforms can achieve - but they couldn't halt the inevitable.<br />
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You can either argue that Germany goes "full Japanese" and tries live on permanent fiscal injection steroids (which clearly the country never will because that is not what its citizens want) or you can accept that it will just have to try what Keynes recommended, and start learning to manage the consequences of population decline. Obviously there is more, much more, to be done in Southern Europe, but trying to look for the problem where it isn't won't help in that endeavor.<br />
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<br />
<b> Postscript</b><br />
<br />
The above arguments are developed in detail and at far greater length in my new book "<a href="http://www.amazon.com/The-Euro-Crisis-Really-Over/dp/1502343436/ref=sr_1_2?ie=UTF8&qid=1410776947&sr=8-2&keywords=edward+hugh"><b>Is The Euro Crisis Really Over?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/Euro-Crisis-Really-Over-Whatever-ebook/dp/B00NKA6PN8/ref=sr_1_2?s=digital-text&ie=UTF8&qid=1410812161&sr=1-2&keywords=edward+hugh">including Kindle</a> - at Amazon.<br />
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Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-69592532047833065132014-10-08T09:27:00.000-07:002014-10-08T09:27:16.000-07:00Is Japan Back In Recession?“People should seriously consider that Japan’s economy may have fallen into recession despite the weaker yen and a stock rally from the BOJ’s easing and the flexible fiscal policy by Abe’s administration,” said Maiko Noguchi, senior economist at Daiwa Securities. “Initial expectations that the economy could withstand the negative effects of a sales tax hike through a virtuous circle seem to be collapsing.”<br />
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"the risks are rising that the economy will later be determined to be in recession,” said Yuji Shimanaka, chief economist at Mitsubishi UFJ Morgan Stanley Securities Co.<br />
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<b>Worsening Picture </b><br />
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As noted in my post - <a href="http://edwardhughtoo.blogspot.com.es/2014/09/does-abenomics-work-doubts-grow.html">Does Abenomics Work?</a> - (published 19 September) the tide of media opinion finally seems to be turning against Shinzo Abe and his economic reform plan for Japan known as "Abenomics". The degree of skepticism being shown only seems to have grown on the back of a slew of recent data confirming the impression that the recovery of economic activity from the post sales-tax slump isn't going to be as easy as either the Japanese government or the Bank of Japan initially thought it would be. As the authors of the Bloomberg report from which the above quotes are taken - <a href="http://www.bloomberg.com/news/2014-09-30/recession-debate-returning-to-japan-as-output-slumps.html">Oops Japan Did It Again? Sales-Tax Spurs Recession Debate</a> - put it: "Weak industrial production data from Japan today raises concern that the world’s third-largest economy may be back in recession, challenging Prime Minister Shinzo Abe’s growth strategy." In fact, output which was down 1.5% between July and August (and down 2.9% over August 2013) has fallen in three of the past five months.<br />
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Other indicators point in a similar direction. Household spending was down 4.7% year on year in August, and the coincident composite index, which consists of 11 key indicators, including retail sales and industrial production, fell 1.4 points to 108.5, according to the Cabinet Office this week. The August drop was the the first fall since June.<br />
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Even corporates are becoming more gloomy. The latest Bank of Japan quarterly Tankan confidence survey fell back three points from June, the second successive fall since it peaked just before the tax hike. <br />
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As the <a href="http://www.ft.com/intl/cms/s/0/b3754530-4919-11e4-9d04-00144feab7de.html#axzz3FFupkoVV">FT's Ben McLannahan points out</a> the Tankan numbers also suggested that "the recent drop in the yen – which fell more than 5 per cent against the US dollar in September – remains a double-edged sword for Japan Inc, pushing up profits for big exporters with extensive overseas operations while squeezing the margins of smaller manufacturers, which struggle to pass on the higher cost of imports." Unsurprisingly it is the small manufacturers who are most disgruntled about the impact of Abenomics.<br />
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The economy fell between April and June by an annualized 7.1% and even though the rate of decline will have been much slower from July to September all the indications seem to point towards the possibility that growth was negative, which would mean that at least technically Japan is back in recession.<br />
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<br />
Abe is having more success with inflation, which is running at the highest level in nearly two decades. Yet even the inflation – which is at an annual 1.3% once you strip out the effects of the tax hike – has largely been driven by the rising cost of imports, and there are serious doubts whether even this will be sustained if there are not further yen devaluations. The Tokyo University frequently purchased items index (obtained from supermarket scanner data) shows underlying inflation continuing to ease.<br />
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<br />
But even the inflation proves to be problematic in a country where wages
constantly fail to rise significantly. The fact that non inflation adjusted
monthly wages rose at the highest rate in I don't know how many years makes a nice
headline, but the fact that real take home pay keeps falling
due to the impact of inflation gives a more realistic description of the difficulties involved in trying to refloat Japanese consumption..<br />
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The theory that is being applied assumes that Japan is in some sort of "temporary" liquidity trap due to the presence of a balance sheet recession, but what if the trap is permanent rather than temporary - see my <a href="http://edwardhughtoo.blogspot.com.es/2014/06/secular-stagnation-part-1-paul-krugmans.html">Paul Krugman's bicycling problem</a> - and is the result of the country's demographic evolution. In that case what - apart from all participating in a mass <a href="http://en.wikipedia.org/wiki/Sisyphus">Labour of Sysiphus</a> - do we really hope to achieve? <br />
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A policy which is exclusively aimed at attaining a positive natural rate of interest when <a href="http://krugman.blogs.nytimes.com/2014/04/09/stagnation-without-end-amen-wonkish/?_php=true&_type=blogs&_r=0">the natural rate may be permanently negative</a> seems of dubious value at the least, and when this policy in addition proves unable to drag the economy stably out of recession and only benefits the 10% of the Japanese population who have financial assets and senior management in large global companies, then in its application it seems almost to be noxious. A state of affairs which doesn't escape the attention of the average Japanese in the street.<br />
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<b>Falling Popularity</b><br />
<br />
The popularity of Prime Minister Shinzo Abe's cabinet was falling sharply going into the summer, forcing him to stage a reshuffle in September. The current approval rating is <a href="http://the-japan-news.com/news/article/0001621770">now back up at 64%</a> but if the country's economic fortunes don't improve it will surely start to head back down again. On the critical question of whether to go ahead with next October's second tax hike, some 68% of those interviewed in the most recent survey say they are opposed while only 28% supported implementation.<br />
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Most market participants assume that the Bank of Japan will react to further bad news by increasing the rate of Japan Government Bond purchases, but it is far from clear that this will happen. Indeed only this week <a href="http://www.bloomberg.com/news/2014-10-07/japan-lawmakers-flag-need-for-exit-strategy-as-yen-falls.html">Bloomberg reports</a> that members of the governing Liberal Democratic Party's governing council are starting to call for the formulation of an exit strategy from the yen weakening process as the debate over the policy's pros and cons grows steadily more intense.<br />
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Meanwhile the Japanese government recently announced that the number of people over 65 reached 25.9% of the population in September – up 1.1 million from a year earlier. Tic-toc, tic-toc.<br />
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***************************************************************<br />
<br />
The above analysis is based on arguments which are fleshed out in much greater detail in my "mini book" the A B E of Economics.<br />
<br />
The book is available with Amazon as an e-book. <a href="http://www.amazon.co.uk/gp/product/B00L4KTLDM?*Version*=1&*entries*=0">It can be found here</a>.
You don't need to buy a Kindle to read this book. You can <a href="http://www.amazon.com/gp/feature.html/ref=kcp_pc_ln_ar?docId=1000426311">download a free app from Amazon</a>.<br />
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Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-73203387417756268332014-09-20T01:38:00.002-07:002014-09-20T01:38:40.950-07:00The Japanisation Of EuropeBy now it should be clear that the monetary experiment currently being carried out in Japan (known as “<a href="http://www.amazon.com/dp/B00L4KTLDM">Abenomics</a>”) is fundamentally different from the kind of quantitative easing which was implemented in the United States and the United Kingdom during the global financial crisis. In the US and the UK QE was implemented in order to stabilize the financial system, while in Japan, and now the Euro Area (EA) the objective is to end deflationary pressures and reflate economies which are arguably caught in some form of liquidity trap.<br />
<br />
In particular it is hard <b>not to draw</b> the conclusion that something structural and more long-term is taking place in Japan, and that that something is only tangentially related to the recent global financial crisis. One plausible explanation is that Japan’s long-lasting malaise is not simply a debt deflationary hangover from the bursting of a property bubble in 1992 but rather with the rapid population ageing the country has experienced. If this is the case then the ongoing economic stagnation in Europe may have a lot more to do with the Japan experience than it does with the recent economic dynamics seen in the UK and the US. The reason for this is simple: Europe’s population is the second oldest on the planet after Japan’s. Certainly at first sight the similarity is striking, especially when it comes to working age population dynamics.<br />
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<b>So is the Euro Area the New "Japan"?</b><br />
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"Europe is becoming Japanese" is an expression that is being used more and more. People saying this normally point to the fact that German 10 year bund yields recently went under 1% (and hence have started to look like 10 year Japan Government Bonds).<br />
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But behind this argument lies some kind of "reverse causality". In Japan JGB yields have been driven to very low levels by central bank intervention, with the BoJ now buying a very large share of all new issue bonds. In Europe, on the other hand, the ECB isn't buying Euro Area sovereigns, <b>the markets are</b> in anticipation of QE. So to talk about the Japanisation of Euro Area yields is a little misleading. Bond purchasers and their models are provoking this downward lurch, not the central bank response to weak growth or creeping deflation. To really push Mario Draghi into Japan-style QE in the short term markets would need to move back into risk-off mode on periphery assets, yet there is little appetite to go for what might potentially become another "widowmaker" trade by taking on a powerful central bank. Yet as long as the bond markets remain relatively well behaved Draghi will try to do as little as possible.<br />
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Another argument used to justify the "Japanisation" of the Euro Area idea carries much more clout, and that is the one being used by Paul Krugman based on working age population dynamics. "If you’re worried that secular stagnation might be depressing the natural real rate of interest (the rate consistent with full employment)”, <a href="http://krugman.blogs.nytimes.com/2014/08/13/whats-the-matter-with-europe/?_php=true&_type=blogs&_r=0">he told blog reader</a>s “and you think that demography is a big factor, Europe looks really terrible, indeed full-on Japanese."<br />
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Inflation dynamics in Europe also look strikingly similar to those seen in Japan (but with a 20 year lag, see chart below). <br />
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<br />
The basic idea is that working age population dynamics play a big part in determining movements in aggregate demand and hence inflation. This idea received support from a research paper published at the start of August by a group of IMF economists - "<a href="https://www.imf.org/external/pubs/cat/longres.aspx?sk=41812.0">Is Japan’s Population Aging Deflationary?</a>" The first part of the paper abstract runs as follows:<br />
<blockquote class="tr_bq">
"Japan has the most rapidly aging population in the world. This affects growth and fiscal sustainability, but the potential impact on inflation has been studied less. We use the IMF’s Global Integrated Fiscal and Monetary Model (GIMF) and find substantial deflationary pressures from aging, mainly from declining growth and falling land prices. Dissaving by the elderly makes matters worse as it leads to real exchange rate appreciation from the repatriation of foreign assets. The deflationary effects from aging are magnified by the large fiscal consolidation need."</blockquote>
Strikingly Japan entered deflation not in 1992, but in 1997/8 at exactly the point the working age population peaked and in the EA it is happening in 2012/13 - just when EA working age population dynamics turned negative. The correlation may be just an odd coincidence, but it is striking.<br />
<br />
<b>Not according to the ECB</b><br />
<br />
Naturally Mario Draghi will have none of this. "I think that the situation in the euro area is quite different from what it was in Japan in the 1990s and early 2000s", he told <a href="http://www.ecb.europa.eu/press/pressconf/2013/html/is131205.en.html">an ECB press conference in December 2013</a>. He then went on to offer five reasons.<br />
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<b>Reason No 1</b>: "we have taken decisive monetary policy measures of great significance at a very early stage, even when, as a matter of fact, inflation was not at the levels at which it is today. It was way higher and way closer to 2% and this did not happen in Japan".<br />
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This<b> is the case</b>, but the vast majority of the ECB's non conventional policy measures were intended to avoid financial instability, not to provoke inflation. The measures were largely liquidity oriented not outright "money printing" ones, so they were mainly addressing the monetary policy transmission mechanism - which was broken - not the fact that the refinancing rate was stuck up against the zero bound. There still hasn't been sufficient analysis of why outright deflation didn't hit the Euro Area sooner, but a big part of the story is probably associated with the presence of excessive rigidity in wages and prices and the constant consumption tax and administrative charge increases put in place as part of the deficit containment exercises.<br />
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It is noteworthy that in Greece, for example, wage costs came down sharply a long time before the CPI began to fall.<br />
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<b><b>Reason </b>No 2</b>: "We are in the process of doing the asset quality review.......the situation in Japan lasted much longer than it should have because the balance sheets of the banking system and the private sector were burdened, and had to be deleveraged and the action to induce this deleveraging lacked for many years."<br />
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Well, maybe, just maybe, the ECB President has his timing a little bit out here. Japan's bubble burst in 1992, and the banks started getting seriously recapitalized in 1998. The global financial crisis hit the Euro Area in 2008, and the AQR - which is supposed to be the prerequisite for realistic recapitalization - is taking place in 2014. The time difference in fact seems to match. So we could also say the necessary action on the part of the ECB also "lacked for many years". Of course, banks in some of the most troubled countries have already been recapitalized once, most notably in Ireland and then in Spain in 2012. But still problems remain, which is why the AQR is taking place. Earlier stress tests have just not been realistic or rigorous enough.<br />
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In a process not too dissimilar to the one taking place at the present time in the EA Japanese banks were recapitalized to the tune of 0.4% of GDP in March 2009, and by another 1.5% of GDP in March 1999. The order of magnitude of these recapitalization is not in any meaningful sense larger than that which is taking place in the Euro Area. Following an AQR type process conducted by the recently formed Japanese Financial Reconstruction Commission non performing loans were systematically identified and banks required to recapitalize accordingly. 14.8% of GDP's worth of NPLs were finally identified, a figure not notably different from the current Euro Area one, and well below the levels prevailing in the worst affected countries like Spain and Italy.<br />
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<b><b>Reason </b>No 3</b>: "the situation of the private sector balance sheets is not at all comparable in the euro area. It is not at all comparable with what it was in Japan at that time."<br />
<br />
I just think Draghi is wrong about this. The level of credit exposure of Japanese banks to the private sector was not *that* different from the EA one in 2008 (see chart below) and as we have seen the level of distressed lending was pretty comparable.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhd1LT7d-Mjq7oPw8zbOlaaMHLYqe9CM9oBENdIeHarBPRygwjcO9j5zGYg9aaqxFxCFpeCpH3ihEjCMjXkaWhNUxraGXUSTDS_Ro_MVxeR2VpCMhYYgvKMo7yYspWC-eBNrZG17V91AZLt/s1600/2014-09-19_191128.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhd1LT7d-Mjq7oPw8zbOlaaMHLYqe9CM9oBENdIeHarBPRygwjcO9j5zGYg9aaqxFxCFpeCpH3ihEjCMjXkaWhNUxraGXUSTDS_Ro_MVxeR2VpCMhYYgvKMo7yYspWC-eBNrZG17V91AZLt/s1600/2014-09-19_191128.png" height="271" width="320" /></a></div>
<br />
<br />
In effect this whole comparison with Japan in the late 1990s is a
bit flawed, since as will be recalled Abenomics was only introduced in
April 2013. The point being that Japan was still stuck in deflation up to that point (and may still be so <a href="http://edwardhughtoo.blogspot.com.es/2014/06/will-japan-re-enter-deflation-in-april.html">when the effects of the devaluation and the tax hike wear off</a>), and so it is a bit hard to pin all this on a couple of bad decisions in 1997 and 1998. Underlying structural factors are at work (liquidity trap, possibly driven by ultra low fertility) and these may be similar in both the European and the Japanese cases.<br />
<br />
It is true that the bank of Japan underestimated the scale of the problem between 1992 and 1997, but the same sort of accusation can be brought to the door of the ECB. In both Japan and the EA measures were (and are being) implemented to help banks avoid liquidity crunches in the hope that this will encourage lending, but in neither case has (or is) this had/having any evident success. The <a href="http://www.bloomberg.com/news/2014-09-18/ecb-targeted-loans-issued-below-estimates.html">poor initial demand for TLTROs</a> being just one example of this problem.<br />
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<b><b>Reason </b>No 4</b>: "countries in the euro area have made significant progress in addressing their structural weaknesses....that’s the fourth difference between Japan in the 1990s and 2000s and us today."<br />
<br />
Well, as Draghi himself admitted, the structural reform process in Europe is far from complete (France, Italy) and I think he also underestimates the kinds of reforms which were carried out in Japan at the time. The "lifelong employment" tradition, for example, was ended in the late 1990s.<br />
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<b><b>Reason </b>No 5</b>: "if you look at the inflation expectations in the euro area and the corresponding inflation rates you would see that in Japan the inflation expectations were dis-anchored quite significantly, and for a long period of time, which is not something we are seeing here."<br />
<br />
This isn't exactly as straight forward as Draghi makes out either. He himself has accepted in his Jackson Hole speech that EA inflation expectations are not as well anchored as he thought they were, while on the other hand inflation expectations were better anchored in Japan than he seems willing to acknowledge (see chart below showing how 10yr inflation expectations evolved in Japan). That is to say<b> in neither case</b> did the central bank see the problem coming. (Click on image for better viewing)<br />
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Bottom line, despite all the denials from Mario Draghi that the Eurozone is not another Japan there are plenty of grounds for thinking that it is steadily becoming one.<br />
<br />
<b> Postscript</b><br />
<br />
The above arguments are developed in detail and at far greater length in my new book "<a href="http://www.amazon.com/The-Euro-Crisis-Really-Over/dp/1502343436/ref=sr_1_2?ie=UTF8&qid=1410776947&sr=8-2&keywords=edward+hugh"><b>Is The Euro Crisis Really 0ver?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/Euro-Crisis-Really-Over-Whatever-ebook/dp/B00NKA6PN8/ref=sr_1_2?s=digital-text&ie=UTF8&qid=1410812161&sr=1-2&keywords=edward+hugh">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-18724271835184191902014-09-19T01:26:00.000-07:002014-09-19T01:26:55.253-07:00Does Abenomics Work? - The Doubts GrowIs something in the air? Do I detect a change in consensus on the way things are going in Japan? Certainly a slew of articles have been published in the financial press over the last month questioning where the Abenomics experiment is headed for. The general conclusion seems to be that wherever it is it is certainly not the originally designated endpoint. Thus<a href="http://www.economist.com/news/finance-and-economics/21617031-harmful-tax-hike-and-reticent-employers-take-their-toll-slings-and-arrows"> the Economist</a>.<br />
<blockquote class="tr_bq">
"It is crisis mode in the Kantei, the office of Shinzo Abe, Japan’s prime minister. A succession of awful data has pummelled his economic programme, which consists of three “arrows”: a radical monetary easing, a big fiscal stimulus and a series of structural reforms. On September 8th revised figures showed that GDP shrank by 1.8% in the second quarter, or by 7.1% on an annualised basis, even worse than the initial estimate of 1.7%."
</blockquote>
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<br />
Or <a href="http://www.ft.com/cms/s/0/ff22e590-374a-11e4-8472-00144feabdc0.html#axzz3DMia18md">David Pilling in the Financial Times</a>:<br />
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<blockquote class="tr_bq">
Something odd is going on with Japan’s labour market. Unemployment is at 3.7 per cent. Recently, it has been as low as 3.5 per cent, considered by some economists to be pretty much full employment....... You would have thought that wage inflation would be going crazy as a result. Unfortunately for Japan, you would be wrong. The government has badgered companies, which are making record profits, to share the love. Some have responded with modest wage increases, but not enough to keep pace with prices, which are rising thanks to monetary stimulus and a 3 percentage-point increase in sales tax......<br />
<br />
Japanese wages do not seem to be responding to normal market pressures. Why not? The conundrum has its roots in the altered structure of the labour market. Contrary to common perception, Japan has an exceptionally flexible workforce. Outside the ranks of the protected “job-for-lifers” – a much rarer breed these days – nearly 40 per cent of workers are about as flexible as you get. They work in poorly paid jobs for hourly rates. Benefits are all but non-existent. For most of these workers, sometimes referred to as the “precariat”, unemployment is a mere “sayonara” away.......<br />
<br />
For its reflationary experiment to work, wages must begin to rise in line with inflation. But the casualisation of the labour force is short-circuiting that process. Moreover, people in the precariat are less likely to marry and have children. If Japan is to solve its demographic problem, it will have to tackle the labour issue.</blockquote>
The WSJ's Takashi Nakamichi - in an article entitled <a href="http://online.wsj.com/articles/japans-tax-increase-puts-abenomics-at-risk-1409302954">Japan's Tax Increase Puts Abenomics at Risk</a>- continues in a similar vein:<br />
<blockquote class="tr_bq">
Mr. Abe took office in December 2012 and quickly engineered an upturn in growth that was dubbed Abenomics. Mr. Abe's policies were backed by the monetary "bazooka" of Bank of Japan Gov. Haruhiko Kuroda, who started flooding the economy with more cash in April 2013.
Though economists warned that the recovery was still fragile, Mr. Abe decided to increase taxes, hoping to reduce Japan's massive debt load.
On Friday, top government officials stuck by their view that Abenomics remains on track. Officials described the downturn in consumer spending as temporary, suggesting it had been exacerbated by rainy summer weather in parts of western Japan.
</blockquote>
Or Stanley White at Reuters (<a href="http://www.reuters.com/article/2014/09/16/us-japan-economy-exports-analysis-idUSKBN0HB2LU20140916">Export recovery proves elusive for hollowed-out Japan</a>) who focuses on the fact that, despite the sharp yen devaluation, exports have hardly improved.<br />
<blockquote class="tr_bq">
Mazda Motor Corp has returned to profit as the falling yen has rewarded the carmaker's export-heavy strategy. Mazda's response? Move some production to Mexico. Investing in plant abroad is hardly an endorsement for Prime Minister Shinzo Abe's strategy to revive the fortunes of the world's third largest economy, and one driven by exports. "Companies are not that interested in expanding capacity in Japan," said Kaori Yamato, senior economist at Mizuho Research Institute. "This is a problem for exports." With companies making less goods at home, it has become structurally difficult for exports to rise, even with the yen at multi-year lows as a result of Abe's policies, economists say.
</blockquote>
In fact White's conclusions seem especially pessimistic. "Economists say the lost production may never come back," he tells us, and he could be right.<br />
<br />
<b>List As Long As Your Arm</b><br />
<br />
The list of arguments about why Abenomics is not working is growing, but the core issues touched on above seem to be:<br />
<br />
i) Unemployment is down, but an excessively flexible labour market means that wages keep falling.<br />
ii) Inflation is rising (partial success) but living standards are falling.<br />
iii) Beyond inflation Abenomics doesn't have clearly defined priorities and fiscal policy continually falls between the two stools of stimulating the economy and reducing the debt: you can't eat your cake and have it.<br />
iv) Times have changed in Japan, the workforce is ageing and to some extent the decline of the export industries may be becoming unstoppable.<br />
<br />
Curiously despite the meager harvest the "put on a brave face" brigade are still out there, and even managed to not feel ridiculous putting up headlines like "<a href="http://online.wsj.com/articles/japan-wages-make-biggest-jump-in-17-years-1409624572">Japan Wages Make Biggest Jump in 17 Years</a>" which is true, but leaves out the inconvenient little detail that inflation is rising at a rate which takes us back even further in time. (See my <a href="http://edwardhughtoo.blogspot.com.es/2014/06/japan-inflation-at-32-year-high.html">Japan inflation at a 32 year high</a>).<br />
<br />
Indeed you have to work your way through to the end of the WSJ article todiscover that "the increase in earnings, however, was negative after accounting for inflation".<br />
<br />
One of the problems external observers have in following Japan is that there are a variety of ways in which wages and salaries are measured and the headline number can vary according to which measure you take. One of the most popular ones is worker household income (published monthly by the statistics office). According to this indicator household income even fell in nominal terms in July (-2.4% see below), and was of course way down in real terms (-6.2%).<br />
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The WSJ journalist chose to cite the preliminary monthly report from the Ministry of Health, Labor and Welfare, which showed average total cash earnings (including bonuses and special payments) rose by 2.6%.in July over a year earlier. Average contractual cash earnings, on the other hand, were up just 0.9%. In both cases you have to subtract the 3.3% annual inflation to find the full impact on wages and earnings.<br />
<br />
In fact the Health, Labor and Welfare ministry also publish a <b>real</b> wages index which is included as part of the same report. This initially showed basic real wages fell by 3% year on year in July. At the end of the day whichever indicator you choose the result has one common thread - it is always negative. (And indeed these preliminary numbers were revised down on Sept 18. Contractual cash earnings went from a 0.9% to a 0.5% non inflation adjusted rise, and real basic wages went from -3% to -3.4%, so there you go).<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgrQ3dHRi4ki6BEllOuxCZqoSeE-RR58pI2LefhClQVnyG9J3o4tenNlp9Mgr2gWGkv3cbhkoeQ5nf6Ms_TuRylZSJL9wG7_s9698ms4i59POQxuKY_v8ib3I8tA3oHCyZ6ahyOJf4zVp8/s1600/japan+real+wages.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgrQ3dHRi4ki6BEllOuxCZqoSeE-RR58pI2LefhClQVnyG9J3o4tenNlp9Mgr2gWGkv3cbhkoeQ5nf6Ms_TuRylZSJL9wG7_s9698ms4i59POQxuKY_v8ib3I8tA3oHCyZ6ahyOJf4zVp8/s1600/japan+real+wages.png" height="189" width="320" /></a></div>
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<b>Inflation May Not Be Sustainable</b><br />
<br />
Then there is the question of whether Japanese inflation is not simply the result of the strong yen devaluation plus the tax increase (I have gone into this at some length <a href="http://edwardhughtoo.blogspot.com.es/2014/06/will-japan-re-enter-deflation-in-april.html">here</a> and <a href="http://edwardhughtoo.blogspot.com.es/2014/06/japan-inflation-at-32-year-high.html">here</a>). Certainly real doubts exist about the sustainability of the current inflation given the lack of final demand to drive it. Economists Tsutomu Watanabe and Kota Watanabe at Tokyo University<a href="http://www.cmdlab.co.jp/price_u-tokyo/daily_e"> maintain a daily price index</a> based on point of sale scanned price data. The index only covers 17 percent of the official Japan CPI in terms of consumption weight, but gives an indication of the trend in frequently purchased items - you can find a list of items covered by the index<a href="http://www.cmdlab.co.jp/price_u-tokyo/faq_e"> here</a>. Certainly - if you look at the chart below its hard to see any clear inflationary push over the last six months, au contraire. (Click on image for better viewing).<br />
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<br />
<b>Exports Going Nowhere</b><br />
<br />
Perhaps the most evident flaw in the Abenomics story is to be found in the export department. The sharp yen devaluation was supposed to lead to a sharp boost in exports which would then drive the economy. And for a time it did.<br />
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<br />
<br />
But then, as Reuters Stanley White points out, the export drive simply ground into the dust, and Japanese exports have been moving sideways since the spring (see chart above). This should be pretty worrying for Abenomics theorists, since the stagnation in exports can't be put down to the tax hike.<br />
<br />
Where we go from here is anyone's guess. The economy is surely going to have a brush with recession this quarter, and in any event it is hard to speak about a recovery in anything except inflation and the stock market.<br />
<br />
Consensus economists are now expecting Bank of Japan governor Kuroda to go for another round of quantitative easing - to force the yen down yet one more time. But why should what didn't work once do any better the second time round? And anyway, Hurhiko Kuroda himself <a href="http://uk.reuters.com/article/2014/09/16/uk-japan-economy-kuroda-idUKKBN0HB0OM20140916">seems to be trying to talk down expectations in this regard</a>. "Japan's economy has been on a path suggesting that the price stability target of 2 percent will be achieved as expected," he told business executives in Osaka last week, adding that "exchange-rate stability is extremely important". This suggests he is not contemplating any further sharp devaluation. Any yen weakening we will see is likely be contained and not pronounced.<br />
<br />
On the other hand the administration still has to decide whether to go ahead with next year's additional tax hike. The government is caught in a double bind, since if it doesn't raise the consumption tax as planned and cuts spending to compensate then the economy will still contract. And if it doesn't do either of these things then the debt level will continue its march upwards. At the moment the government is mulling the idea of raising the tax and <a href="http://www.bloomberg.com/news/2014-09-11/japan-seen-needing-47-billion-stimulus-for-next-tax-bump.html">doing a 5 trillion yen ($47 billion) additional stimulus</a> to compensate. Which sort of leaves me wondering why they want to raise the tax in the first place.<br />
<br />
What makes people like me nervous is the thought that if the central bank can't deliver on its promise to deliver inflation and revive the economy, or if the Japanese voters decide they have had enough of the experiment, then a loss of confidence might ensue, and all those dubious risky asset positions might unwind suddenly, just like an earlier set did in 2008.<br />
<br />
And there are plenty of people in Japan who have been pointing this out all along. Seki Obata, a Keio University business school professor for example, who in 2013 published a book "Reflation is Dangerous," argues exactly this, that "Abenomics" is exposing Japan to considerable risk without any clear sense of what it can accomplish. Obata also makes the extremely valid point that there is simply no way incomes can rise across the entire economy because the baby boomers are now retiring to be replaced by fewer young workers with post labour reform entry-level wages. Japan's overall consumer spending power will therefore fall, rather than rise as Abe hopes. "Individual companies may offer wage increases, but because of demographics it is simply impossible to increase the total amount that is paid out in wages," says Obata. "On the contrary, that amount will shrink."
Simple logic you would have thought, but logic in the face of irrational exuberance scarcely stops people in their tracks.<br />
<br />
As far as I can see, all of this points to one simple and evident conclusion: that Japan needs deep seated cultural changes, especially ones directed to greater female empowerment and more open-ness towards immigration. Hardly matters for central bank initiatives, and indeed ones for which Shinzo Abe, who naturally has given his name to this new economic trend, is singularly ill equipped to carry through. Japan needs a series of structural reforms – like those under discussion around the third arrow – but these would be to soften the blow of workforce and population decline, not an attempt to run away from it. Monetary policy has its limits. As Martin Wolf <a href="http://www.ft.com/intl/cms/s/0/b94e6c00-7dd3-11e3-95dd-00144feabdc0.html#axzz34hdetIbk">so aptly put it</a>, "you can't print babies".<br />
<br />
The above analysis is based on arguments fleshed out in much more detail in my "mini book" the A B E of Economics.<br />
<br />
The book is available with Amazon as an e-book. <a href="http://www.amazon.co.uk/gp/product/B00L4KTLDM?*Version*=1&*entries*=0">It can be found here</a>.
You don't need to buy a Kindle to read this book. You can <a href="http://www.amazon.com/gp/feature.html/ref=kcp_pc_ln_ar?docId=1000426311">download a free app from Amazon</a>.<br />
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Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-53419482811176671282014-09-16T05:52:00.000-07:002015-03-31T00:03:46.894-07:00Is The Euro Crisis Really Over?The euro zone crisis is not back --, at least not yet it isn’t. <br />
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Despite the great progress which has been made over the last few years, the latest bout of market tensions over Greece serve to illustrate the degree of uncertainty which still hangs over the future of monetary union - will a so-called Grexit scenario will finally occur? <br />
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Certainly the most notable feature of the current Greece crisis is the way in which bond yields in the other Euro periphery countries have continued to head downwards, leading many to conclude that the “contagion” threat is now a thing of the past. But doubts remain: how much of this bond yield stability is due to the ECB QE programme? And what will happen if the ECB eventually terminates the bond purchases, or even tries to end them early under a Federal Reserve type “tapering” process? What will happen to bond spreads then? And what about the growing political instability in the region, as unemployment remains unacceptably high despite the apparent recovery. <br />
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Naturally the dramatic shift in market perceptions of Southern Europe which has taken place since the height of the crisis has surprised many. For some the level of investor appetite for shares and bonds in what was previously deemed an economic disaster zone is a sure sign another bubble is on the way, this time in government bonds. For others it is proof that the debt crisis is now well behind us, and indeed that the most seriously affected economies have now “turned the corner”. <br />
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For the time being the “Mario Draghi ultimately has my back” feeling continues to prevail, but with markets increasingly financing debt levels that many recognize as ultimately unsustainable nervousness will rise that the size of the pill – and German resistance to the process - may become just too big for the ECB to comfortably swallow, leaving the specter of private sector involvement (PSI) in debt restructuring to once more rear its ugly head. <br />
<br />
Meanwhile, long term issues about the sustainability of Europe’s economies are emerging, largely for demographic reasons. Unable to adjust via a classic devaluation, and unwilling to bite the bullet of a sizeable adjustment in relative prices via an internal devaluation, economies in southern Europe are correcting via the long-wished-for route of transnational labour mobility. But as explained here, the associated migration process is not without problems in an era when working age populations are tilting downwards and elderly population ratios steadily on the rise. <br />
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One possible solution to many of these problems would be a complete federation of all Euro Area member states: the long talked about full political union. This wouldn’t be an instant cure all for the region’s problems but it would make the correction of country level imbalances much more manageable. Unfortunately there is little appetite for such a move on the part of those countries which would be large net contributors, and hence this outcome seems unlikely over the relevant time horizon. Instead we are witnessing a continuing battle between periphery and core Europe politicians over getting the ECB to continue with full blown QE to sustain debts, creating in the process a transfer union which has no visible transfers. <br />
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There is no doubt that both the participating countries and the Euro Area itself have made significant institutional advances during the crisis. But has enough been done, or have one can after another simply been kicked down the road? Certainly the unresolved issues are not hard to identify: low GDP growth, high unemployment, rising sovereign debt levels, creeping deflation, how to handle the problem of ageing and declining workforces. There plenty of potential sources for more crises, the issue is whether there is the will to address them before something happens, or whether the driver will, yet one more time, fall asleep at the wheel. <br />
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************************************************************* <br />
<br />
These arguments are developed at greater length in my new book "<a href="http://www.amazon.com/The-Euro-Crisis-Really-Over/dp/1502343436/ref=sr_1_2?ie=UTF8&qid=1410776947&sr=8-2&keywords=edward+hugh"><b>Is The Euro Crisis Really 0ver?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/Euro-Crisis-Really-Over-Whatever-ebook/dp/B00NKA6PN8/ref=sr_1_2?s=digital-text&ie=UTF8&qid=1410812161&sr=1-2&keywords=edward+hugh">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-18144535418565991012014-09-11T02:31:00.000-07:002014-09-11T23:59:29.827-07:00The Catalan Vote: Why It's Time To Start Getting Worried About Complacency In MadridWhen Barack Obama told a CNBC interviewer last autumn that Wall Street ought to be "genuinely worried about what is going on in Washington" in reference to the US government shutdown he raised more than a few eyebrows. Normally political leaders try to calm and reassure markets, so this attempt to stir them up on the part of the US President was, in its way, something of a first. <br />
<br />
Last May the Financial Times <a href="http://www.ft.com/intl/cms/s/0/619a8200-d201-11e3-8ff4-00144feabdc0.html#axzz3CzXTdlND">issued a similar warning</a> in an editorial with a clear message: right now you should be more worried than you are about what is happening in Madrid. According to the newspaper, “secessionist demands have created a rolling crisis involving Catalonia and the national government in Madrid,” a crisis which it warns could end in a “head on collision” if the issues being raised are not addressed.<br />
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The issues have not been addressed, and there is now a provisional date for that woeful collision to occur: the 9 November this year, the date chosen by the Catalan parliament for the holding a popular (non binding, not a referendum) consultation under a new law which will receive parliamentary approval on 19 September. The original intention of the Catalan parliament was to hold a referendum on the region’s future authorized by Madrid. With that intent parliamentary representatives took a proposal last spring to the Spanish parliament. The reply was a polite but near unanimous “no” since Spain’s parliamentarians took the view any such vote could be considered “unconstitutional”.<br />
<br />
As Mariano Rajoy pointed out, given the way the Spanish Constitution is currently worded neither he, nor even the Spanish parliament, have the power to authorize such a vote. The Spanish prime minister’s view was also endorsed recently by the country’s constitutional court, who ruled that the proposed referendum would be unconstitutional under the terms of the constitution as it stands. The court however added an important rider to the judgment, a rider to do with the political problem of legitimacy. If in a discrete part of the national territory, the court suggested, a significant majority of the population are not satisfied with the current arrangements, and these arrangements are not changed, then a constitutional crisis ensues.<br />
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Thus the issue moves from being a purely juridical one to a political one, and any eventual solution - even if this means accepting Catalan independence - needs in essence to be political. Effectively the court threw the ball back into the politicians’ court: if the constitution doesn’t permit a vote it can be changed, if there is the political will to do so. Amending the constitution didn’t seem to be such an insurmountable obstacle at the height of the sovereign debt crisis, when agreement was reach between the various parties in a matter of days to place constitutional limits on the level of government debt, a fact which does not escape the attention of those Catalans who feel themselves in urgent need of the right to a vote.<br />
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This is also what the FT had in mind when the editorial argued “it is disingenuous” for Mariano Rajoy “to hide behind the Spanish constitution”. Sooner or later democracy will out. This is why the newspaper argues the Spanish government needs to urgently formulate some sort of counter proposal, along the lines of the so called “third way”: an approach going beyond the current arrangements but falling short of full independence. The core of such a proposal, the paper argues, would be an improved fiscal arrangement, and more autonomy. <br />
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In the opinion of the present author these proposals look fine on paper, but arriving at any sort of agreement on them seems highly unlikely. In the first place, Spain’s ongoing economic issues make the financing of any new fiscal agreement extremely problematic. The economy may be showing signs of recovery, but it is a weak and fragile one, and the aftermath of the country’s property bust will cast a shadow of at least a decade over the country’s economic future. In addition there is no easy “win-win” solution available, since letting the Catalans keep more of their own money will undoubtedly mean someone else will receive less. Who will that someone else be? A glance at the political arithmetic shows that the major Spanish party closest to considering the third way is the socialist PSOE. But PSOE relies on votes from the country’s most populous region – Andalusia – and this would surely be one of the areas most negatively affected any substantial fiscal change.<br />
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More autonomy sounds nice, but what exactly would it look like? Would it allow the region, for example, to opt out of laws which are highly unpopular in Catalonia like the recent abortion one or the proposal to make bullfighting form part of the national heritage? And what about the identitarian issues which are really what lie at the heart of the current tension? From the Spanish point of view, the most contentious of the Catalan demands is their claim to have their identity as a nation included in any rewritten constitution. Any addressing of this long standing grievance would seem to open the door to solving another, that of having national sports teams to compete in international competitions. Are Spaniards – not simply Madrid politicians – ready for this? <br />
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Then there is the language. Far from the impression being given that Spaniards are getting more and more comfortable with linguistic coexistence the situation seems to be quite the opposite, with moves to restrict the use of the language in schools having taken place in the regions of Valencia, the Balearic Islands, and Aragon, in each of which there are significant Catalan speaking communities. Even in Catalonia proper the central government is currently trying to implement an education reform which restricts the autonomy of the Catalan education minister to decide matters of language policy. It is hard to see in any of this a reflection of a will to improve relations.<br />
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It seems to me that such feelings of national identity affect both Spaniards and Catalans. They are strong and deep seated, on both sides, and far more important than the economic ones. The difficulty is they cannot be changed either in committee or overnight. I repeat, is there any real sign of a desire among the Spanish population to make the sort of attitude changes which a successful implementation of a third way would imply? President Mas visited Prime Minister Rajoy in the Moncloa in July to discuss the situation. He presented a list of 23 issues about which they could talk. To date the Spanish Prime Minister has not replied. He seems content simply to chant the mantra "there will be no vote". But as the Constitutional Court pointed out you cannot generate political legitimacy by only explaining what won't happen.<br />
<br />
Naturally this "no" to the possibility of voting has come to the forefront in recent days with the publication of an opinion poll showing that the "yes" vote might win in Scotland. <br />
<br />
As for the Catalans, we have yet to discover what it is they really want. This is what the demand for a vote is all about, so that the wishes of Catalans can be registered in a fashion which goes beyond the innumerable opinion polls. Determining what people actually want is a basic prerequisite so that the democratic process can then go to work. In the meantime they will simply look on in envy on the 18 September as Scots exercise their basic right.<br />
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What then happens next? The Catalan parliament will on 19 September pass into law a formula which will allow opinion seeking, non-binding consultations to be held under Catalan rather than Spanish law. It is not clear at this point whether the Madrid government will challenge this law. Possibly they won't, since it is probably not unconstitutional. Then the Catalan parliament will pass as second decree law convening a consultation with an already announced question for the 9 November. Madrid have already made clear that they will not permit this question to be asked and will take the matter to the Constitutional Court.<br />
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Which brings us to 9 November itself: if it is not possible to have a vote then Catalonia’s President Mas has suggested he might call plebiscitary elections. The purpose of these elections would not be – as some suggest – to authorize the parliament to declare UDI, but to establish the size of the majority in favor of a vote. The newly constituted parliament will then have the responsibility for deciding what to do next.It would be a mistake to think that these elections - if held - would be the end of the matter. They will take the collision onto a new level and generate a very high degree of uncertainty about where things are going from that point on.<br />
<br />
So although the world will not change on November 10, and even if there are elections instead of a vote on independence the outcome could well produce a definitive sea change about how Catalans view their relations with Spain. They may well mark a “point of no return”. So to go back to where we started. Right now global markets and most of the international press are being pretty sanguine about the situation, when – as President Obama suggested in the case of the US government crisis – perhaps they shouldn’t be. Perhaps they should be worried about the complacency in Madrid, and remember that one of the principal ways of letting something unexpected happen is to assume it won’t.
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-2213744038364031242014-09-04T05:36:00.000-07:002014-09-19T04:33:46.671-07:00Secular Stagnation Part III - The Expectations Fairy"So what's going on here? Well, it might sound like a hokey religion, but central banking is really a Jedi mind trick. Just saying something can be enough to make it happen. That's because the power of the printing press gives their words a distinct power. Well, that and the fact that the economy is already one big self-fulfilling prophecy." - Matt O'brien, "<a href="http://www.washingtonpost.com/blogs/wonkblog/wp/2014/08/13/abenomics-has-only-worked-because-foreigners-think-it-will/">Abenomics has only worked because foreigners think it will</a>"<br />
<br />
"Lucas thought he could do better. His major innovation in his seminal 1972 article was to get rid of the assumption (implicit and often explicit in virtually every previous macro model) that government policymakers could persistently fool people." - The Concise Encyclopedia of Economics, "<a href="http://www.econlib.org/library/Enc/bios/Lucas.html">Robert Lucas</a>".<br />
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Of course, if we knew - really knew - that one got much more reliable results by doing the things that <i>ad-hoc</i> macro does not, it would be a tool to be used only for the most preliminary examination of issues. But do we know that? - Paul Krugman, <a href="http://web.econ.unito.it/bagliano/macro3/krugman_orep00.pdf">How Complicated Does the Model Have to Be?</a><br />
<br />
"It is unfair for Keynesians to be making fun of the people who call for
austerity by saying “confidence fairy” when they are making similar
expectational-shift arguments themselves." - Brad DeLong, <a href="http://delong.typepad.com/sdj/2013/06/confusion.html">Confusion: High Public Debt Levels and Other Sources of Risk in Today's Macroeconomic Environment</a><br />
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"You can fool some of the people all of the time, and all of the people some of the time, but you can not fool all of the people all of the .... Abraham Lincoln <br />
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<span style="font-size: small;"><b>Exiting a Liquidity Trap</b></span><br />
<span style="font-size: small;"><b> </b></span> <br />
The classic solution to the problem posed by a demand slump when monetary policy becomes ineffective due to the operation of a liquidity trap is a credible commitment to future inflation (see for example Paul Krugman's 1998 <a href="http://www.princeton.edu/~pkrugman/japans_trap.pdf">Japan's Trap</a>). This commitment reduces the real interest rate despite the presence of a zero bound and thus stimulates spending, and it does so through the impact of the commitment on expectations about future inflation. In <a href="http://krugman.blogs.nytimes.com/2013/04/11/monetary-policy-in-a-liquidity-trap/?_php=true&_type=blogs&_r=0">a later blog post</a> Krugman himself puts it like this:<br />
<blockquote class="tr_bq">
"Here’s the thing, however: the economy won’t always be in a liquidity trap, or at least it might not always be there. And while investors shouldn’t care about what the central bank does now, they should care about what it will do in the future. If investors believe that the central bank will keep the pedal to the metal even as the economy begins to recover, this will imply higher inflation than if it hikes rates at the first hint of good news – and higher expected inflation means a lower real interest rate, and therefore a stronger economy.
So the central bank can still get traction if it can change expectations about future policy."</blockquote>
The tricky part is, as he goes on to note, this commitment won't convince if investors fear that at the first sign of good news the normally staid and serious central bankers revert to type and snatch away the punch bowl. An old Greek fable catches the feel of the situation remarkably well:<br />
<blockquote class="tr_bq">
"A lion is trapped in a deep hole. A fox passes by and the lion asks it to pass down a tree branch. The lion makes many promises about the reward it will give the fox if it escapes from the trap. The fox understands that the lion is hungry and that once escapes the trap it will simply eat it. Once the lion is free from the trap it has no incentive to fulfill its promise but has every reason to make the fox its meal." </blockquote>
So the central bank has to commit to future inflation in a way which credibly convinces investors that they are not going to be turkey's participating in a Christmas promotion campaign. In an attempt to get over this his (at the time) PhD student Gauti Eggertsson came up with a set of proposals - in a paper entitled <a href="http://www.imf.org/external/pubs/ft/wp/2003/wp0364.pdf">Committing to Being Irresponsible</a> - where the core idea was that removing central bank independence would make the commitment more credible, presumably because politicians are known to have a lower anti-inflation bias than central bankers. Eggertsson puts it like this:<br />
<blockquote class="tr_bq">
"In this paper the zero bound is binding because of large shocks that make the Central bank unable to lower the nominal interest rate enough to prevent deflation and a deleterious decline in output. We show that in the presence of these shocks there is instead a deflation bias of a discretionary independent Central Bank." <br />
<br />
"In a liquidity trap the Central Bank would best achieve its goals if it could commit to moderate future inflation in order to maintain price stability and keep employment close to potential. If it is a discretionary maximizer it cannot, however, do this because its announcements are not credible. The result is a liquidity trap characterized by excessive deflation and undesirably low output." </blockquote>
Krugman uses exactly the same expression at the end of the post I cite above: "The hope now is that things have changed enough at the Bank of Japan that this time it can, as I put it all those years ago, 'credibly promise to be irresponsible'". So the question is, why isn't this short term irresponsibility - I presume the idea is that they don't go being irresponsible on forever (although see below) - some variant of what Matt O'brien calls the Jedi mind trick?<br />
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<br />
At the heart of the problem lies the issue of expectations, and what you can get people to credibly believe. <a href="http://en.wikipedia.org/wiki/Baron_M%C3%BCnchhausen">Baron von Münchhausen</a> was reputedly able to pull himself up by his own bootstraps , why don't you go try it?<br />
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The reasonable conclusion to draw is that expectations really are constantly at work in day to day economic processes, even if we don't fully understand the mechanisms through which they work, and it is a perfectly plausible approach - and not simply a Jedi mind trick - to adopt a policy aimed at changing people's expectations. Especially if the problem you are trying to deal with is deflation rather than inflation. As Mario Draghi says in his standard definition of deflation: “Deflation is a protracted fall in prices across different commodities, sectors and countries. In other words, it is a generalised protracted fall in prices, with self-fulfilling expectations." So obviously to break out of deflation you have to change expectations. <br />
<br />
But the question arises: in the case of the deflation we are seeing in Europe and Japan is that possible?<br />
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Maybe it would be a good economic outcome for us all to practice levitation. But - despite what some may think - we won't be able to do so simply because some government agency or other works hard to try to convince us that we all can. We need to think to some extent about the mechanics of flight. <br />
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Something similar is evidently the case with deflation. We need to think about the causes and whether or not the proposed solutions work before we can decide whether or not the attempt to generate (at the central bank or elsewhere) the appropriate expectation is achievable. If we think the current deflation is just an expectations issue – and not a phenomenon with deep roots in the real economy – we may well end up leading ourselves totally astray.<br />
<br />
<br />
<b>Postscript</b><br />
<br />
These arguments <span style="font-size: small;">form part of a chapter in<b> </b></span>my new book "<a href="http://www.amazon.com/The-Euro-Crisis-Really-Over/dp/1502343436/ref=sr_1_2?ie=UTF8&qid=1410776947&sr=8-2&keywords=edward+hugh"><b>Is The Euro Crisis Really 0ver?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/Euro-Crisis-Really-Over-Whatever-ebook/dp/B00NKA6PN8/ref=sr_1_2?s=digital-text&ie=UTF8&qid=1410812161&sr=1-2&keywords=edward+hugh">including Kindle</a> - at Amazon.<br />
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-21821314072357167192014-08-17T09:41:00.001-07:002014-09-16T05:51:09.585-07:00The Italian Runaway TrainThere has been lot's of debate in the press and in academic circles over the last week or so about <a href="http://www.voxeu.org/article/italian-growth-new-recession-or-six-year-decline">whether Italy's latest contraction constitutes a triple dip recession</a> or simply a continuation of what's been going on over many many years. This is an interesting theoretical nicety, but in fact what is happening in Italy at the moment goes a lot further than problems faced by a recession dating committee. The real issue that arises in the context of the Euro Area at the moment is a far more specific one. Will the ECB do QE? And if it does when will it push the button? And what could happen if it doesn't. Perhaps a case study of the Italian case is worth the effort here. What is likely to happen to Italian debt if there is no ECB intervention soon? Let's take a look at the dynamics.<br />
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By now almost everyone and their grandad knows that Italy is back in recession following the 0.2% GDP contraction in the second quarter.<br />
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Not only did this result suggest that Italy was now in a triple dip recession (or a twenty year decline), it also meant that GDP was back at the same level it had in 2000, when the country entered the Euro currency union.<br />
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The problem is that Italy has an appallingly low trend GDP growth rate - possibly negative at this point - and nothing which has happened since the financial crisis ended suggests it is going to to improve radically anytime soon, in fact there are good reasons to think that growth could even deteriorate further.<br />
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In the first place Italy's working age population is now falling, and <a href="http://blogs.ft.com/ftdata/2014/02/27/renzis-hidden-problem-the-brain-drain/?infernofullcomment=1&SID=google">many young educated Italians are leaving to work elsewhere</a>. <br />
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And now, not only do we have the legacy then of high debt and low growth, a new problem has emerged: low inflation or even deflation. Italy's inflation has fallen to zero.<br />
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The combination of low inflation and low growth means that it is the evolution of nominal GDP that really matters now. Nominal GDP is non inflation corrected GDP (or GDP at current rather than constant prices). If inflation remains low or even becomes negative, then nominal GDP will hardly increase and may even continue to contract (as has happened in Japan). The result is bound to be that the gross government debt to GDP ratio rises above the 135.6% it hit in March.<br />
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One of the arguments frequently advanced about how this dynamic could be turned around would be for Italy to run a "large" primary budget surplus. Now the emphasis here is on <b>large</b> since the country has in fact run a primary surplus (income - expenditure before paying debt interest) since the early 1990s, but that hasn't stopped the weight of the debt climbing and climbing.<br />
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The IMF,<a href="http://www.imf.org/external/pubs/ft/fm/2013/01/pdf/fm1301.pdf"> in their 2013 Fiscal Monitor</a> outlined a scenario in which the obligations of heavily indebted European sovereigns first stabilise, and then fall to the 60% level targeted by the EU’s Fiscal Compact by 2030. It makes assumptions regarding interest rates, growth rates and related variables, and computes the cyclically adjusted primary budget surplus (the surplus exclusive of interest payments) consistent with this scenario. As they point out, the heavier the debt, the higher the interest rate and the slower the growth rate, the larger the requisite surplus. In fact they found that the average primary surplus required in the decade 2020-2030 was 5.6% for Ireland, 6.6% for Italy, 5.9% for Portugal, 4.0% for Spain, and 7.2% for Greece. <br />
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Is it plausible that Italy could run an average primary surplus of 6.6% of GDP over a decade? Hardly - in particular this implies that on average, every year, the government would be draining out 6.6% of GDP from domestic demand via taxation. Yet as I have noted many times, domestic demand is precisely the weak point in the Italian economy (secular stagnation, ageing population). <br />
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As Eichengreen and Panizzi (<a href="http://www.voxeu.org/article/can-large-primary-surpluses-solve-europe-s-debt-problem">who studied the plausibility of the IMF projections</a>) conclude:<br />
<blockquote class="tr_bq">
"These are large primary surpluses. There are both political and economic reasons for questioning whether they are plausible.............History suggests that such behaviour, while not entirely unknown, is exceptional....... On balance, this analysis does not leave us optimistic that Europe’s crisis countries will be able to run primary budget surpluses as large and persistent as officially projected." </blockquote>
Italy's situation is to some extent replicated in other countries on the periphery (Ireland sovereign debt to GDP 124%, Portugal 132.9%, Spain 96.8% and Greece 174.1%, all numbers as of March 2014) since almost all official forecasts anticipate an imminent turnaround in the debt dynamic. If secular stagnation and ultra low inflation really set in this turnaround is going to be impossible to achieve and Europe's leaders will need to decide what to do about it. <br />
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Italy's debt now looks certain to climb towards 140% of GDP and beyond (maybe hitting that level as early as Q1 2015), meaning someone somewhere in the official sector should be able to recognize that it is not on a sustainable path. The so called AQRs (bank Assett Quality Reviews) are probably not going to generate too many surprises, but what about doing some realistic DSA's (Debt Sustainability Analyses)? <br />
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Cases like Greece and Portugal are to some extent containable from an EU perspective since the economies are small enough for EU leaders to engage in some sort of extend and pretend via low coupons and long horizon maturities. But Italy's debt is simply too big to be manageable in this way.<br />
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So EU leaders and the ECB now face a dilemma. Trying to make Italy comply with its EU deficit and debt obligations may well mean that the deficit comes down but in all probability the debt level will go up (given the weak nominal GDP effect). Not complying with them opens the possibility of stimulating slightly more growth (and possibly mildly stronger inflation) but naturally the debt level will rise. It's a sort of damned if I do and damned if I don't situation, since either way the debt burden rises.<br />
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From the point of view of the country's political leaders though, it is obvious that austerity today has costs (and few visible benefits) while deficit spending may bring some short term benefit at the price of hypothetical longer term debt issues. It shouldn't surprise us then if they go for the latter, especially since Japan's political leaders have been widely applauded for doing something similar.<br />
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Naturally, since the difficulties the onset of secular stagnation will produce for heavily indebted countries with ageing and shrinking workforces are not widely understood, hints that deficit objective relaxation calls are growing have not been well received everywhere. During the spring <a href="http://www.ft.com/intl/cms/s/0/d7b79578-a000-11e3-9c65-00144feab7de.html?siteedition=intl#axzz2v7QHse3y">the FT published</a> details of a document jointly issued by the German and Finnish finance ministries which strongly rebuked Brussels for easing austerity demands, citing in particular the additional flexibility given to France and Spain for reducing their budgets to within EU deficit limits. <br />
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“Since 2012, the commission has substantially changed the way it assesses whether a member state has taken ‘effective action’ to comply with [EU budget rules],” the memo states. “The recent methodological changes imply the risk of watering down the newly strengthened [rules] at its implementation stage.”<br />
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As might have been expected, Matteo Renzi was not slow in coming forward to seek similar treatment for his country (See "<a href="http://www.ft.com/intl/cms/s/0/9472a5da-c659-11e3-ba0e-00144feabdc0.html?siteedition=intl#axzz2z7srnzJ8">Italy request to push back budget targets dismays Brussels</a>" FT April 17). According to the newspaper the country's finance minister, Pier Carlo Padoan, sent a formal written request to the commission on 16 April seeking authorisation for a change in objectives. Citing the “severe recession” that set Italy back in 2012 and 2013, Mr Padoan wrote that Italy wanted to “<b>deviate temporarily from the budget targets</b>” and that because of “<b>exceptional circumstances</b>” (my emphasis throughout) the government had decided to accelerate the payment of arrears owed by the public to the private sector by €13bn, which would increase the debt to GDP ratio in 2014. The trouble is that these "temporary factors" and "exceptional conditions" seem to arise with a predictable regularity in Italy's case. The country is currently aiming for a balanced structural budget in 2016 rather than 2015 as agreed with Mario Monti’s technocrat government in 2012. A year earlier, then prime minister Silvio Berlusconi had promised a balanced structural budget by 2013.<br />
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<b>Enter Mario Draghi</b><br />
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The relationship between Mario Draghi and Matteo Renzi has long been a source of speculation and gossip. Shortly after he came to office in February following a kind of palace revolution inside his own party whereby the incumbent Prime Minister - Enrico Letta - was unceremoniously defenestrated the Financial Times Brussels correspondent even published a post on an FT blog with the rather direct title: <a href="http://blogs.ft.com/the-world/2014/02/does-renzi-owe-his-job-to-draghi/">Does Renzi owe his job to Draghi?</a> <br />
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The gist of the article was an attempt to establish some sort of connection between Matteo Renzi's arrival in office and the the outcome of the then recent German Constitutional Court ruling which put into question the viability of the central bank's OMT (Outright Monetary Transactions) programme. Spiegel's hypothesis was that the driving force for some kind of "unholy alliance" between the two of them lay in Draghi's interest in getting prime minister Letta out of office before pressure from within Germany about maintaining open the offer of a now legally questionable OMT programme to an Italy which was visibly enjoying cheaper bond yields - but was manifestly not advancing with its reform programme - became too strong to withstand.<br />
<blockquote class="tr_bq">
"Do last week’s German constitutional court ruling lambasting – but failing to overturn – the ECB’s crisis-fighting bond-buying programme and Matteo Renzi’s ousting of Italy’s prime minister Enrico Letta have anything in common? In the view of many ECB critics, particularly in Berlin, the two are not only related, but one may have caused the other."<br />
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"In the view of many German critics, there has been no serious effort by the Italian government – be it in the fading months of Mario Monti’s premiership or during Enrico Letta’s foreshortened tenure – to undertake major economic reforms since ECB boss Mario Draghi first announced he would do “whatever it takes” to save the euro in July 2012."</blockquote>
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The key part of the background here is that the German court ruling effectively left OMT - which only ever had a virtual existence and was increasingly seen as an empty bluff since it was clear no one was going to accept the conditionality side - deader than that infamous dead duck. Karlsruhe's objection to the existing bond buying programme was that it went beyond the ECB's mandate since directly financing government debt is prohibited under Maastricht, and the objective of OMT was to help governments finance at an affordable price. Since break-up risk - which could have offered an alternative justification for OMT - is for the moment off the table, OMT lacked definitive legal justification and in practical terms the emperor visibly had no clothes. It was just a question of how long the markets needed to wake up to the fact.<br />
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So it was imperative to find some other justification for the initiation of a bond purchases programme should one be needed. Then along came deflation. The important point is that if a programme of bond purchases is implemented as a form of QE it will differ from the earlier OMT programme in terms of the justification offered. Any QE programme introduced to combat deflation would be implemented as part of an attempt to attain price stability, an objective which does lie within the central bank mandate. Another key difference is that if QE is launched and involves bond purchases the bank will buy bonds from ALL countries in the monetary union (according to their weight in Euro Area GDP), which brings us to the third difference from OMT: there will be no conditionality attached. Given this it became a "high risk" operation and it was clear that Mario Draghi needed someone else at Italy's helm if he wanted to be able get the Germans on board with QE, someone who could convince them Italy would enact the required reforms. Enter Matteo Renzi. <br />
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Now fast forward to August, and we find the former mayor of Florence who had surged to office on the back of promises to enact aggressive labour market reforms, a battery of spending and tax cuts and significant privatizations has been strong on talking and very weak on action. Something which is not uncommon in Italy, but people had expected more. They thought this time was different.<br />
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Mario Draghi's irritation with the situation was visible <a href="http://www.ft.com/intl/cms/s/0/8f677018-2066-11e4-b8f4-00144feabdc0.html#axzz3AXl5FSh2">at the August ECB press conference</a>. When asked by one of the journalists why Italy had fallen back into recession he could hardly contain himself, and was unusually direct in saying a lack of structural reforms was holding the country back and hampering a return to growth. The reference to Renzi was evident.<br />
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One week later <a href="http://www.reuters.com/article/2014/08/13/us-italy-economy-idUSKBN0GD19N20140813">the two met</a>, in what they had obviously hoped would be a secret meeting but Italy being Italy the press went along for the ride. While no details of what happened at this meeting have transpired it is pretty clear Draghi will have used the opportunity to read his fellow countryman the riot act. Italy has been full of talk about some kind of Troika intervention, but this is most unlikely, and Renzi made it pretty clear <a href="http://www.ft.com/intl/cms/s/0/3e790e94-208b-11e4-890a-00144feabdc0.html#axzz3AXl5FSh2">in his Financial Times interview</a> that he personally wouldn't be asking for one.<br />
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When asked why Italy's reform pace seemed so slow he rejected Draghi's suggestion that the EU should intervene in countries where reforms were not being implemented fast enough. “I agree with Draghi when he says that Italy needs to make reforms but how we are going to do them I will decide, not the Troika, not the ECB, not the European Commission,” he said. “I will do the reforms myself because Italy does not need someone else to explain what to do."<br />
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The problem is that with the debt dynamics we have seen above the one thing Italy doesn't have at this point is time. It isn't a problem of the impact of a so called "debt snowball" as interest rate payments send debt levels spiraling upwards. If anything it's worse. Mario Draghi can, in theory, contain the debt interest problem, and if needs be along with it the capital repayments schedule. But the problem Italy has at the moment is one of the credibility of its debt, of the country being able to convincingly argue its trajectory is sustainable, of being able to convince the Germans that if the ECB were to buy bonds these they could EVER be redeemed.<br />
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While Renzi has waxed eloquently about transforming Italy, buoyed on by the results of the European Parliament elections he seems more concerned with pushing through electoral reform - which is obviously needed but is not perhaps as pressing as the growth and debt problem - leaving the suspicion that he is more interested in getting re-elected than anything else. Indeed the fact that he needs the support of the discredited former Prime Minister Silvio Berlusconi to get the reform through with any kind of urgency (see <a href="http://www.newsweek.com/italy-slips-back-recession-new-pm-seeks-berlusconis-help-263267">Italy Slips Back Into Recession, As New PM seeks Berlusconi's Help</a>) has lead critics of the two "institutional parties" to suggest the reform may be more about getting rid of newcomers like Beppe Grillo's Five Star movement than anything else (see <a href="http://www.thelocal.it/20140725/government-lays-bear-trap-for-senate-reform">Renzi slammed for "coup" over senate changes</a>) .<br />
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To date Renzi's government - which is almost operating outside real historical time in terms of economic issues - has made little progress on the sort of reforms which might help the country recover some kind of growth, like those to the judicial system and the labor market. The only measure that could be considered vaguely "pro-growth" that his government has enacted was the 80 euro bonus delivered to low-wage workers hasn't boosted the economy as its proponents claimed. The measure seems more cosmetic - comparable with José Luis Zapatero's ridiculous "Plan E" in Spain - and only reinforces the impression of politicians fiddling while Rome burns. The business lobby Confcommercio, which was highly critical of the measure, <a href="http://www.nwitimes.com/news/national/europe/lobby-govt-bonus-hasn-t-boosted-italy-s-economy/article_70fa6911-6c79-548a-bd92-83641afc2772.html">calculated that consumption was boosted by just 0.1% in June</a>, the first month in which the tax relief was operative. In their press release they said Italian families were holding back from shopping “because their uncertainty about the future was stronger than the actual increase in funds in their pockets”.<br />
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Despite this Prime Minister Renzi continues to insist that his government's economic strategy is sound and will lift the country out of crisis.<a href="https://uk.news.yahoo.com/italian-pm-renzi-defies-critics-recession-returns-201217933--business.html#TDAhB4E">In a lengthy interview broadcast on La7 television</a> following the announcement of the GDP results, Renzi said that his government was determined to get the economy back on track, but in due course. "We will work better and harder, but I promised to change direction, not to change the universe in three months time," Renzi said, adding that only a "comic book superhero" could turn around the economy in a matter of months. "Calmly, serenely, we are taking this country by the hand and pulling it out of the crisis," Renzi told listeners.<br />
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The problem outside observers are having is not in seeing the complete turnaround - Renzi is right here, this involves a long painful road - but in identifying the first baby steps that are being taken.<br />
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And fears about Mr Renzi’s grasp on Italy’s finances were fanned again last week when spending review commissioner <a href="http://it.wikipedia.org/wiki/Carlo_Cottarelli">Carlo Cottarelli</a> highlighted the tensions which existed in the government over the prime minister’s spending plans. In <a href="http://revisionedellaspesa.gov.it/blog.html">a post on his blog</a>, Mr Cottarelli - who was appointed by Letta and was previously <a href="https://www.imf.org/external/np/bio/eng/ccot.htm">Director of the Fiscal Affairs Department at the IMF</a> - said that earlier savings were already being used by parliament for other expenditure, meaning that in the longer term they could not be used to reduce taxes on employment (which is what they were intended for).<br />
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Renzi normally responds to critics that all points of view are valid but 11 million Italians think differently, in a clear reference to what he perceives to be his electoral support. But even this will eventually wane if progress is not seen to be made on the economy. <a href="http://www.ft.com/intl/cms/s/0/eaaeffe0-1d7d-11e4-8f0c-00144feabdc0.html?siteedition=intl#axzz3AXl5FSh2">The FT quotes</a> Wolfango Piccoli, analyst at Rome-based think-tank Teneo, to the following effect: “As prime minister Matteo Renzi struggles to make progress on political reform, it is becoming increasingly clear that his government lacks an original and coherent plan for the economy,” <br />
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To add insult to injury, more bureaucratic delays mean that the treasury will not hit its target to raise €12bn from privatizations this year. There are also concerns about the outcome of the European Central Bank’s stress tests and asset quality review of the country’s leading banks. Bankers point out that if an Italian bank needs a bail out the state’s coffers will not easily be able to support it. Of course here we have a mighty instrument which Draghi can use to twist Renzi's arm.<br />
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Another issue is labour market reform. The controversial <a href="http://www.gazzettadelsud.it/news/english/104078/-Article-18-just-an-ideological-totem--says-Renzi.html">Article 18 of Italy's workers statute is "just a symbol"</a>, and "debating it is a pointless exercise", Renzi told State broadcaster RAI 3 last week. The comments came after Interior Minister Angelino Alfano, who comes from the New Center Right (NCD) party, called for its abolition. Article 18 of the 1970 Workers Statue is a law that forbids companies with over 15 employees from firing people without just cause. <br />
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The Italian Prime Ministers reluctance to tackle the labour market issue is understandable. Any attempt to really change Italian labour law would be deeply unpopular on the left (and even among many in his own party) and a direct clash with Italy's unions would surely cost him votes if his plan is to hold elections after passing a new electoral law. More fiddling while Rome Burns.<br />
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<b>So Which Way For The ECB?</b><br />
<br />
Evidently members of the EU Commission, ECB governing council members, and senior political leaders in Berlin, Amsterdam or Paris are neither theoreticians nor intellectuals. The secular stagnation hypothesis is at this point more akin to a theoretical research strategy than a workable template for policy-making, and policymakers are understandably reluctant to take decisions on the basis of what is still largely a hypothesis. <a href="http://www.voxeu.org/article/secular-stagnation-facts-causes-and-cures-new-vox-ebook">As the editors of a recent book on the topic</a> put it in their introduction: "Secular stagnation proved illusory after the Great Depression. It may well prove to be so after the Great Recession – it is still too early to tell. Uncertainty, however, is no excuse for inactivity. Most actions are no-regret policies anyway". As they suggest the risks here are far from evenly balanced. If countries like Japan, Italy and Portugal are suffering from some local variant of one common pathology, then normal solutions are unlikely to work, and matters can deteriorate fast.<br />
<br />
Naturally the ECB can go down the Abenomics path, and institute large scale sovereign bond purchases even while the Commission turns an increasingly blind eye to higher deficit spending at the country level. But it is far from clear that Abenomics works (see <a href="http://edwardhughtoo.blogspot.com.es/2014/08/abenomics-what-could-possibly-go-wrong.html">here</a>) and if it doesn't what happens to all the accumulated debt?<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSfkmp7AU6G1ToyyddHlOZ605RttetUoPCVGYJfpHcylPORbSX36CYehPwrFbYXGZj8VDB3mGKpBk5SZuph6u0FmVsTDAjkdLafWsgsEx-ZHBVLYor9AIiw6uRCCgcVn24cQKbU6Un6VWH/s1600/2014-08-06_103529.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSfkmp7AU6G1ToyyddHlOZ605RttetUoPCVGYJfpHcylPORbSX36CYehPwrFbYXGZj8VDB3mGKpBk5SZuph6u0FmVsTDAjkdLafWsgsEx-ZHBVLYor9AIiw6uRCCgcVn24cQKbU6Un6VWH/s1600/2014-08-06_103529.png" height="233" width="320" /></a></div>
<br />
<br />
On the other hand time always has a cost. Letting things drift further means letting debt levels rise, and risking testing market patience and this becomes especially important in the cases of Italy and Portugal. The longer time passes the more difficult it is going to be for anyone to convince themselves that the debt of these countries is sustainable.<br />
<br />
So there may come a point after which the Germans simply will not allow Draghi to buy Italian bonds without a prior haircut. OK, they've said they won't do more PSI, but they've said a lot of things, and the cost of irritating investors is limited when you have a regional current account surplus and a central bank buying bonds.<br />
<br />
Maybe the costs of the Euro "widowmaker" trade will be borne by all those eager bond purchasers who thought nothing could possibly go wrong. I am sure German politicians would decide a loss of credibility on PSI would be less costly to them than getting German taxpayers on the hook for current Italian debt levels. Especially in a country <a href="http://in.reuters.com/article/2014/08/14/germany-economy-debt-idINL6N0QK1PN20140814">where they are now proudly announcing</a> they have reduced government debt for the first time in more than 50 years. So in this case, maybe the turkeys just did vote for Xmas.<br />
<br />
The thing is, despite the meeting between Draghi and Renzi (who may also be a turkey by Xmas) nothing substantial is going to happen in Italy. The government is under no pressure to ask for help (and doesn't even feel it needs it), and Draghi won't act before things change. Gridlock - with rising debt. <br />
<br />
Naturally in the short term the “Mario Draghi ultimately has my back” feeling will still prevail, but with markets continuing to finance debt levels that any official study will soon have to recognize as unsustainable lack of proactive policies from the ECB will only fuel concerns that the size of the pill may become just too big for the bank to persuade Germany comfortably swallow, leaving the specter of private sector involvement to once more rear its ugly head. How do you tell people who have just sacrificed hard to get their debt under control that they are now about to help "pardon" 50% of someone else's. It simply doesn't make sense.<br />
<br />
************************************************************* <br />
<br />
These arguments are developed at greater length in my new book "<a href="http://www.amazon.com/The-Euro-Crisis-Really-Over/dp/1502343436/ref=sr_1_2?ie=UTF8&qid=1410776947&sr=8-2&keywords=edward+hugh"><b>Is The Euro Crisis Really 0ver?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/Euro-Crisis-Really-Over-Whatever-ebook/dp/B00NKA6PN8/ref=sr_1_2?s=digital-text&ie=UTF8&qid=1410812161&sr=1-2&keywords=edward+hugh">including Kindle</a> - at Amazon.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBQQdNRTkPuVgM7aXN1u9dq7LP9r2Ylzt9pH3015lJ2LukpOSDvliKZq6kz4ggV-zkoAYshyphenhyphenbeYL5IowPi5KQ5QPh0tjAESZDl_r9oN4TMRzmifVvf7nZO_0n7FIqjDj-K1Jtv3RrCBmfw/s1600/2014-09-13_183508.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBQQdNRTkPuVgM7aXN1u9dq7LP9r2Ylzt9pH3015lJ2LukpOSDvliKZq6kz4ggV-zkoAYshyphenhyphenbeYL5IowPi5KQ5QPh0tjAESZDl_r9oN4TMRzmifVvf7nZO_0n7FIqjDj-K1Jtv3RrCBmfw/s1600/2014-09-13_183508.png" height="320" width="214" /></a></div>
<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-23461407960427008912014-08-17T02:20:00.001-07:002014-09-16T00:50:09.020-07:00What Is The Risk The Euro Crisis Will Reignite?The euro zone crisis is not back -- at least not yet. <br />
<br />
Recent movements in global markets following concerns about Portugal’s Banco Espirito Santo really had as much to do with market nerves after a long spell of repressed volatility as it did with the state of the bank’s balance sheet. Despite the current calm, everyone knows that volatility will return one day, and no one wants to be caught on the back foot when it does arrive. So the initial response is to hit the “sell” button and then ask questions.<br />
<br />
Beyond this context, there is a lack of certainty in the market about which way bond yields for the so-called “peripheral” euro zone countries are heading in the near term -- and what exactly the risks associated with holding them really are. Riding the yield compression, in the case of the Portuguese 10-year bond from over 7 percent to under 3.5 percent was a one-way-bet no-brainer once the impact of Draghi’s July 2012 speech became crystal clear.<br />
<br />
But now yields have started to tick up again, so the advantages of holding in anticipation of further declines become less obvious, while the risks continue to mount. In many ways, the situation is analogous to yen depreciation and the Bank of Japan. The first leg was easy, as the yen fell into the 100 to 105 to USD range. But now it is stuck there, and the debate has become a “will she, won’t she” on further BoJ easing.<br />
<br />
It is clear the recent European Central Bank decision to launch Targeted Long-Term Refinancing Operations has disappointed. TLTRO's may do something to help ease access to credit in the south in the mid-term, but they will hardly be effective in combating deflation. In particular, we may need to wait more than six months to see any net liquidity impact, since the September and December allocations coincide with earlier LTRO repayments, leaving what Pantheon Macroeconimcs’ Claus Vistesen calls “a potentially worrying ‘air-pocket’ over the next six months where the central bank’s balance sheet continues to contract, making the verbal commitment to easing increasingly difficult to rely on as a sole back-stop."<br />
<br />
Will we really have to wait till 2015 to see any significant step to try to stop the deflation rot?<br />
<br />
Digging deeper, and beyond fears about what the coming ECB bank stress tests may turn up, the simple passage of time in itself could complicate things. The recent round of numbers has had everyone busily revising down their 2014 growth forecasts, and it is obvious that even if outright deflation is avoided inflation will be very, very low. In fact whether or not the Euro Area slumps back into outright recession or not seems to depend more on Vladimir Putin than on the ECB at the moment,<br />
<br />
But the key point to take away from all this is that nominal GDP over the next couple of years may barely increase, with the knock on consequence that sovereign debt levels in the most indebted countries will surely be jolted onwards and upwards. This is important since all official sector projections have these levels peaking either this year or next, but now these estimates will surely need to be revisited.<br />
<br />
Second quarter GDP data was horribly bad. France's economy stagnated, but more worryingly for policymakers Germany relapsed (minus 0.2 q-o-q), leaving Spain as the only one of the "big four" to put in a positive growth performance (0.6 q-o-q). While the immediate drag on short-term growth may well be the impact on sentiment of a crisis on the frontier between Ukraine and Russia, the Euro Area is now clearly stuck in some form of longer term <a href="http://edwardhughtoo.blogspot.com.es/2014/06/secular-stagnation-part-1-paul-krugmans.html">secular stagnation</a>. The daylight just around the next recovery corner argument rings hollower and hollower with each successive loss of momentum.<br />
<br />
"Europe is becoming Japanese" is an expression you hear more and more. People saying this normally point to the fact that German 10 year bund yields have now gone under 1% (and hence have started to look like 10 year JGBs). <br />
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<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgb3N6DyZUuNdaxtbkSp0gWkkMYec9CjB0IVnymPUq1_s1Xj_idhLHJIWSYtvBQqQOuemzfbPMMQ2rrKtP7M2qqZn4ZBaDaVXJc7bGPFJ3J6IER3kGsC5sFhnfS63Rm3zhFd-OYA9Qz6TEF/s1600/2014-07-29_105453.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgb3N6DyZUuNdaxtbkSp0gWkkMYec9CjB0IVnymPUq1_s1Xj_idhLHJIWSYtvBQqQOuemzfbPMMQ2rrKtP7M2qqZn4ZBaDaVXJc7bGPFJ3J6IER3kGsC5sFhnfS63Rm3zhFd-OYA9Qz6TEF/s1600/2014-07-29_105453.png" height="161" width="320" /></a></div>
<br />
But behind this argument lies some sort of version of "reverse causality". In Japan JGB yields have been driven to very low levels by central bank intervention, with the BoJ now buying a very large share of all new issue. The ECB isn't buying Euro Area sovereigns, the markets are in anticipation of QE. So to talk about the Japanification of Euroa Area yields is a little misleading. Bond purchasers and their models are PROVOKING this downward lurch, not weak growth or deflation. To push Mario Draghi into QE markets would need to move back into risk-off mode on periphery assets.
As long as the bond markets remain well behaved Draghi will do as little as possible, as I will discuss below.<br />
<br />
Another argument used to justify the "Japanisation" of the Euro Area idea carries much more clout, and that is the one being used by <a href="http://krugman.blogs.nytimes.com/2014/08/13/whats-the-matter-with-europe/?module=BlogPost-Title&version=Blog%20Main&contentCollection=Opinion&action=Click&pgtype=Blogs&region=Body">Paul Krugman based on working age population dynamics</a>.<br />
<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqkqWaTMLSJDXULXtTzT2fZfSBRbCkwnJXCRHyou3lo3O-j1hjnhMppFDCbNybMh1DF2QoaDbR7hHwX83G2sFxpfuwPN89oEZplIpS3hyV5Z8EViP5D_ywseKqG5nYKFi43nFjBjP6rsgE/s1600/2014-07-29_131442.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqkqWaTMLSJDXULXtTzT2fZfSBRbCkwnJXCRHyou3lo3O-j1hjnhMppFDCbNybMh1DF2QoaDbR7hHwX83G2sFxpfuwPN89oEZplIpS3hyV5Z8EViP5D_ywseKqG5nYKFi43nFjBjP6rsgE/s1600/2014-07-29_131442.png" height="168" width="320" /></a></div>
<blockquote class="tr_bq">
"If you’re worried that secular stagnation might be depressing the natural real rate of interest — the rate consistent with full employment — and you think that demography is a big factor, Europe looks really terrible, indeed full-on Japanese."
</blockquote>
The basic idea is that working age population dynamics play a big part in determining movements in aggregate demand and hence inflation (see my secular stagnation summary <a href="http://edwardhughtoo.blogspot.com.es/2014/06/secular-stagnation-part-1-paul-krugmans.html">here</a>). This idea received support from <a href="https://www.imf.org/external/pubs/cat/longres.aspx?sk=41812.0">a research paper published at the start of August</a> by a group of IMF economists - "Is Japan’s Population Aging Deflationary?" (authors Derek Anderson, Dennis Botman and Ben Hunt). The first part of the abstract runs as follows:<br />
<blockquote class="tr_bq">
"Japan has the most rapidly aging population in the world. This affects growth and fiscal sustainability, but the potential impact on inflation has been studied less. We use the IMF’s Global Integrated Fiscal and Monetary Model (GIMF) and find substantial deflationary pressures from aging, mainly from declining growth and falling land prices. Dissaving by the elderly makes matters worse as it leads to real exchange rate appreciation from the repatriation of foreign assets. The deflationary effects from aging are magnified by the large fiscal consolidation need."</blockquote>
Bottom line, despite all the denials from Mario Draghi that the Eurozone is not another Japan there are plenty of grounds for thinking that it will be.<br />
<br />
<b>So Which Way For The ECB?</b><br />
<br />
Evidently members of the EU Commission, ECB governing council members, and senior political leaders in Berlin, Amsterdam or Paris are neither theoreticians nor intellectuals. The secular stagnation hypothesis is at this point more akin to a theoretical research strategy than a workable template for policy-making, and policymakers are understandably reluctant to take decisions on the basis of what is still largely a hypothesis. <a href="http://www.voxeu.org/article/secular-stagnation-facts-causes-and-cures-new-vox-ebook">As the editors of a recent book on the topic</a> put it in their introduction: "Secular stagnation proved illusory after the Great Depression. It may well prove to be so after the Great Recession – it is still too early to tell. Uncertainty, however, is no excuse for inactivity. Most actions are no-regret policies anyway". As they suggest the risks here are far from evenly balanced. If countries like Japan, Italy and Portugal are suffering from some local variant of one common pathology, then normal solutions are unlikely to work, and matters can deteriorate fast.<br />
<br />
Naturally the ECB can go down the Abenomics path, and institute large scale sovereign bond purchases even while the Commission turns an increasingly blind eye to higher deficit spending at the country level. But it is far from clear that Abenomics works (see <a href="http://edwardhughtoo.blogspot.com.es/2014/08/abenomics-what-could-possibly-go-wrong.html">here</a>) and if it doesn't what happens to all the accumulated debt?<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSfkmp7AU6G1ToyyddHlOZ605RttetUoPCVGYJfpHcylPORbSX36CYehPwrFbYXGZj8VDB3mGKpBk5SZuph6u0FmVsTDAjkdLafWsgsEx-ZHBVLYor9AIiw6uRCCgcVn24cQKbU6Un6VWH/s1600/2014-08-06_103529.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSfkmp7AU6G1ToyyddHlOZ605RttetUoPCVGYJfpHcylPORbSX36CYehPwrFbYXGZj8VDB3mGKpBk5SZuph6u0FmVsTDAjkdLafWsgsEx-ZHBVLYor9AIiw6uRCCgcVn24cQKbU6Un6VWH/s1600/2014-08-06_103529.png" height="233" width="320" /></a></div>
<br />
<br />
On the other hand time always has a cost. Letting things drift further means letting debt levels rise, and risking testing market patience and this becomes especially important in the cases of Italy and Portugal. The longer time passes the more difficult it is going to be for anyone to convince themselves that the debt of these countries is sustainable.<br />
<br />
So there may come a point after which the Germans simply will not allow Draghi to buy Italian bonds without a prior haircut (see my "Italian Runaway Train" <a href="http://italyeconomicinfo.blogspot.com.es/2014/08/the-italian-runaway-train.html">here</a>). OK, they've said they won't do more PSI, but they've said a lot of things, and the cost of irritating investors is limited when you have a regional current account surplus and a central bank buying bonds.<br />
<br />
Maybe the costs of the Euro "widowmaker" trade will be borne by all those eager bond purchasers who thought nothing could possibly go wrong. I am sure German politicians would decide a loss of credibility on PSI would be less costly to them than getting German taxpayers on the hook for current Italian debt levels. Especially in a country <a href="http://in.reuters.com/article/2014/08/14/germany-economy-debt-idINL6N0QK1PN20140814">where they are now proudly announcing</a> they have reduced government debt for the first time in more than 50 years. So in this case, maybe the turkeys just did vote for Xmas.<br />
<br />
The thing is, despite the meeting between Draghi and Renzi (who may also be a turkey by Xmas) nothing substantial is going to happen in Italy. The government is under no pressure to ask for help (and doesn't even feel it needs it), and Draghi won't act before things change. Gridlock - with rising debt. <br />
<br />
Naturally in the short term the “Mario Draghi ultimately has my back” feeling will still prevail, but with markets continuing to finance debt levels that any official study will soon have to recognize as unsustainable lack of proactive policies from the ECB will only fuel concerns that the size of the pill may become just too big for the bank to persuade Germany comfortably swallow, leaving the specter of private sector involvement to once more rear its ugly head. How do you tell people who have just sacrificed hard to get their debt under control that they are now about to help "pardon" 50% of someone else's. It simply doesn't make sense.<br />
<br />
************************************************************* <br />
<br />
These arguments are developed at greater length in my new book "<a href="http://www.amazon.com/The-Euro-Crisis-Really-Over/dp/1502343436/ref=sr_1_2?ie=UTF8&qid=1410776947&sr=8-2&keywords=edward+hugh"><b>Is The Euro Crisis Really 0ver?</b></a> - <b>will doing whatever it takes be enough</b>" - on sale in various formats - <a href="http://www.amazon.com/Euro-Crisis-Really-Over-Whatever-ebook/dp/B00NKA6PN8/ref=sr_1_2?s=digital-text&ie=UTF8&qid=1410812161&sr=1-2&keywords=edward+hugh">including Kindle</a> - at Amazon.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBQQdNRTkPuVgM7aXN1u9dq7LP9r2Ylzt9pH3015lJ2LukpOSDvliKZq6kz4ggV-zkoAYshyphenhyphenbeYL5IowPi5KQ5QPh0tjAESZDl_r9oN4TMRzmifVvf7nZO_0n7FIqjDj-K1Jtv3RrCBmfw/s1600/2014-09-13_183508.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBQQdNRTkPuVgM7aXN1u9dq7LP9r2Ylzt9pH3015lJ2LukpOSDvliKZq6kz4ggV-zkoAYshyphenhyphenbeYL5IowPi5KQ5QPh0tjAESZDl_r9oN4TMRzmifVvf7nZO_0n7FIqjDj-K1Jtv3RrCBmfw/s1600/2014-09-13_183508.png" height="320" width="214" /></a></div>
<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-8111502739933834132014-08-14T10:46:00.002-07:002014-08-14T10:46:46.168-07:00Abenomics - What Could Possibly Go Wrong?If this week's economics news is positive then that is good. But if it's bad then that's even better, since there is more potential for it to improve next week, and if it doesn't, well that's doubly better since there will be even more reason for central banks to step in and push up asset prices. Maybe all this sounds peculiar, even perverse, but it would seem to be how many people working in financial markets are reasoning these days.<br />
<br />
In an article entitled "Why Japan's GDP Plunge Isn't As Bad As It Seems", Bloomberg writer Bruce Einhorn <a href="http://www.businessweek.com/articles/2014-08-13/japans-gdp-contracts-6-dot-8-percent-investors-dont-panic">put it like this</a>:<br />
<blockquote class="tr_bq">
The last time Japan raised the consumption tax, in 1997, the economy went into a tailspin. The impact doesn’t seem to be as bad this time, though. The economy contracted at an annualized 6.8 percent in the second quarter of the year. Bad, to be sure, but not dismal. For all its severity, the plunge was actually smaller than many economists had expected, with a survey of 37 economists by Bloomberg showing a median estimate of a 7 percent decline.
That’s why investors looked at today’s numbers and shrugged. </blockquote>
Takeshi Minami, chief economist at the Norinchukin Research Institute in Tokyo also felt the number wasn't a disaster, since he <a href="http://www.bloomberg.com/news/2014-08-12/japan-economy-shrinks-the-most-since-2011-quake-on-tax.html">told Bloomberg</a> despite the sharp fall, “the probability is high that the July-September quarter will see a rebound.” Well, naturally, after a 19.2% annualised drop in household consumption, or a 35.3% drop in residential investment doing better won't be hard, but that's a kinda low bar to be working from.<br />
<br />
Another line of argument you can find repeatedly in the financial press is that the number was a bad one, but the silver lining is that this means the Bank of Japan is more likely to do additional QE. “The contraction was sharp. There is no argument about that,” Toshihiro Nagahama, chief economist at Dai-Ichi Life Research Institute<a href="http://blogs.wsj.com/briefly/2014/08/12/5-takeaways-from-japans-gdp-2/"> told the Wall Street Journal</a>, however he had “no doubt” the government and the Bank of Japan would come under pressure to act as a result. Pressure from whom? As we will see later, maybe not from Japanese the citizens these institutions are supposed to represent.<br />
<br />
At the end of the day what matters isn't whether Japan's economy grows slightly (or not) in the coming quarter, but whether the country is on a stable recovery path or whether growth will continue to remain lackluster and weak even as the government debt level rises.<br />
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<br />
Apart from the obvious shockers, details worth noting are the 1% of GDP's worth of quarterly inventory accumulation (see chart above), which will have to be sweated down in the next quarter, and the 20.5% annualized fall in imports. This was good for the net trade component, which was positive for the first time in yonks, but the fall is simply the reverse side of the consumption drop. In fact Japanese export growth has been weakening steadily in recent months, and this obviously has nothing to do with the sales tax.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhYwpxfBfvDi9jEHZLGKyhsL1krJDTGZJdNq0sG7ghFJYO5BFWjFuWsrI70aZjf7CYS39iDCyIK43DUrqRiztGiUza6rMwnZ3meApX7KY1NlxGMoKFLDzVJ1SOxHVQAyMEapudT6IJ1T58/s1600/japan+exports+yoy.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhYwpxfBfvDi9jEHZLGKyhsL1krJDTGZJdNq0sG7ghFJYO5BFWjFuWsrI70aZjf7CYS39iDCyIK43DUrqRiztGiUza6rMwnZ3meApX7KY1NlxGMoKFLDzVJ1SOxHVQAyMEapudT6IJ1T58/s1600/japan+exports+yoy.png" height="158" width="320" /></a></div>
<br />
Exports were down 2% in June over a year earlier, and in volume terms they were down 2.5% from September 2012, just before the Abenomics driven yen devaluation started. So if one of the objectives of Abenomics was boosting exports it is obviously failing. As Naohiko Baba, chief Japan economist at Goldman Sachs Group and former central bank employee<a href="http://www.bloomberg.com/news/2014-08-10/japan-tallies-weak-yen-as-prices-rise-without-export-gain.html"> told Bloomberg</a>: “The BOJ predicted that a weak yen would boost export volumes and spur
spill-over effects by increasing domestic production and expanding the
overall economy -- but that path isn’t working. It raises the question of what the weak yen has done in terms of living standards of the general public.”<br />
<br />
It seems that manufacturers have been moving production to lower-cost countries during the years of yen strength, thus reducing the effect of exchange rates on exports. Honda, for example, has more car production capacity in North America than its home market and last year exported more vehicles from its U.S. factories than it imported into the country from Japan.<br />
<br />
<b>Inflation Surge Weakening? </b><br />
<br />
The Bank has had more success with inflation since core inflation was up 3.3% over a year earlier in June. But that number soon shrinks in proportion when you strip out the estimated impact of the recent tax hike. According to the Bank of Japan the ex-tax number for June was 1.3%, down from 1.4% a month earlier. And even this inflation isn't demand driven: it is largely a carry over from the earlier yen devaluation. As such it is quite likely to disappear with time.<br />
<br />
Representatives of the Bank of Japan continue to insist that the country is on course to exit deflation, but many external observers aren't convinced, as this recent chart from analysts at Credit Suisse suggests. <br />
<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhYzzp9fDe3pl3P1-qaCA5Y-Cq5blKmbswD-MjHFTAmjKoGk7P5lzbLvGnlEAU8z5M0G8cGgfDqgGShN6nq0Rns7auXW-k6ZrXtMlOvXCKtd77dfWz2jz-LM2KLqN7h5wPr_LX8eMMovCU/s1600/2014-08-14_141539.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhYzzp9fDe3pl3P1-qaCA5Y-Cq5blKmbswD-MjHFTAmjKoGk7P5lzbLvGnlEAU8z5M0G8cGgfDqgGShN6nq0Rns7auXW-k6ZrXtMlOvXCKtd77dfWz2jz-LM2KLqN7h5wPr_LX8eMMovCU/s1600/2014-08-14_141539.png" height="247" width="320" /> </a></div>
<br />
<br />
As the <a href="http://online.wsj.com/articles/the-end-of-japans-inflation-affair-1406473045">Wall Street Journal put it</a>:<br />
<blockquote class="tr_bq">
"The latest data, which exclude the effects of April's consumption-tax hike, suggest that Japan is slipping away from the 2% inflation target set by Mr. Abe's central banker, Haruhiko Kuroda. Price increases for imports, triggered by a yen-devaluation campaign, have now filtered through the economy. Since Abenomics hasn't included concrete economic reforms, Japan is sliding back into its status quo before Mr. Abe was elected in late 2012."</blockquote>
<b><br /></b>
<b>Winners and Losers</b><br />
<br />
Another problem which faces Abe is that the results of his policy have been very unevenly distributed.Those who gained from the yen devaluation (shorting the yen) or from the rise in Japanese equities, or those corporates who made windfall profits on their sales have been the lucky ones, because the rest of the Japanese have been facing falling living standards. As the <a href="http://www.economist.com/news/asia/21611152-even-jobs-grow-scarce-real-wages-continue-fall-feeling-pinch?fsrc=scn/tw/te/pe/feelingthepinch">Economist pointed out</a>: even as jobs grow scarce, real wages continue to fall. <br />
<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYQCMWl_WbmWiTxwJMsWT_n9EJ3ospoAG4_uj4D3rp-89d8iPey9I9LiLAh4-8hr9qIuJLuXOS58EWFc2VKaUt-Oc-IcSbbNxJCxSALJWARJgRcTbnCdAZD80axx1th1Q7thCgqvoDPJQ/s1600/2014-08-14_155432.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYQCMWl_WbmWiTxwJMsWT_n9EJ3ospoAG4_uj4D3rp-89d8iPey9I9LiLAh4-8hr9qIuJLuXOS58EWFc2VKaUt-Oc-IcSbbNxJCxSALJWARJgRcTbnCdAZD80axx1th1Q7thCgqvoDPJQ/s1600/2014-08-14_155432.png" height="306" width="320" /></a></div>
<br />
<br />
Nominal wages have been rising again in Japan.
Average total wages, consisting of base pay, overtime and bonuses covering both regular and part-time workers, grew 0.4% on year in June, following increases of 0.6% for May and 0.7% for April and March. Four straight months of year-on-year risse is the longest stretch since total wages grew for six straight months between June and November 2010. But real wages - which take into account inflation and matter much more to consumers than nominal wages, declined 3.8% on year in June, the fourteenth consecutive month of decline, and the biggest drop since December 2009. <br />
<br />
<b>Shadow Over Abenomics?</b><br />
<br />
Not unnaturally many Japanese are starting to get fed up with Premier Abe and his economics revolution. What good to them is a policy which only helps the upper 10% of the population and the overseas investment community. Tokyo University's Shin-ichi Fukuda <a href="http://www.cirje.e.u-tokyo.ac.jp/research/conf/abenomics0307/SFukuda.pdf">has carried out some pretty interesting research</a> in this regard. As can be seen in the two charts reproduced below, most of the movement in both the Nikkei has taken place while the Japanese themselves were offline and asleep.<br />
<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi1vXncQZ64tr9Q1Fod6sDsdwk4g-IpxgHCuN12UT-V5nOPRa-oFvG5Vb-aJpnYJGJron0fkWbgP-L9vZf3rcV__MPOO-8-agnYns38mb65mZ4yQ5FXlT_Tdp0jpCzOTJAYctztz3YmjJ8/s1600/2014-08-14_163004.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi1vXncQZ64tr9Q1Fod6sDsdwk4g-IpxgHCuN12UT-V5nOPRa-oFvG5Vb-aJpnYJGJron0fkWbgP-L9vZf3rcV__MPOO-8-agnYns38mb65mZ4yQ5FXlT_Tdp0jpCzOTJAYctztz3YmjJ8/s1600/2014-08-14_163004.png" height="216" width="320" /></a></div>
<br />
And pretty much the same picture emerges if we look at movements in the yen.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgq9KKcLUFJxeclegbdWaEuVerKJWLECoQ9jxNfGVWOLwf0z5M4R2STmttpT1CgiHxeASDHm8CmKm2EJY3Wg-d4btqDY1Sues76PXk2Ez19c3BIMToZGR2DGXfQkFLESMjcK3di9fnsfEw/s1600/2014-08-14_163026.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgq9KKcLUFJxeclegbdWaEuVerKJWLECoQ9jxNfGVWOLwf0z5M4R2STmttpT1CgiHxeASDHm8CmKm2EJY3Wg-d4btqDY1Sues76PXk2Ez19c3BIMToZGR2DGXfQkFLESMjcK3di9fnsfEw/s1600/2014-08-14_163026.png" height="193" width="320" /></a></div>
It shouldn't surprise us then to find that Shinzo Abe's popularity is plummeting in Japan.
Opinion surveys conducted in July by Japan’s major newspapers show Abe’s support ratings have fallen below 50 per cent for the first time since he became Premier, while the number of people who say they disapprove of his government is approaching the number who say they approve.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYojFdHH-COzsuMgj7NQaiD4MDb3aXh9ZTQ_K_jcnjIdpux3JCAnNslulrfaIyk-xH7TIs3W_Jbm6G1AkDKcnzshAVa0TExD5ohzBJ12Ke5bGt-w3G_Jjlz9OsA2vxR044CJ-5QppbvDw/s1600/2014-08-01_132541.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYojFdHH-COzsuMgj7NQaiD4MDb3aXh9ZTQ_K_jcnjIdpux3JCAnNslulrfaIyk-xH7TIs3W_Jbm6G1AkDKcnzshAVa0TExD5ohzBJ12Ke5bGt-w3G_Jjlz9OsA2vxR044CJ-5QppbvDw/s1600/2014-08-01_132541.png" height="163" width="320" /></a></div>
<br />
<br />
And at the heart of the dissatisfaction lies the governments economic policy. A recent survey published by the Sankei newspaper showed 47 per cent of respondents said they disapproved of his government’s handling of the economy, 7 percentage points more than the number who approved.The Sansei, <a href="http://www.ft.com/intl/cms/s/0/d88ec8dc-1543-11e4-85bc-00144feabdc0.html#axzz391YQpZGK">described by the FT's Jonathan Soble</a> as a "right-leaning" daily that has mostly "cheer-led" for Abe, had a headline stating "There is a shadow over Abenomics". As Soble says one of the reasons for such dissatisfaction among many Japanese "is simply that Abenomics has made them poorer, thanks to its uneven effect on prices and wages."<br />
<br />
So while many in the markets and in the academic community think the obvious response to what is happening in Japan will be more BoJ easing, the Japanese themselves may not see it this way. <br />
<br />
Part of the reason they might not see it in the same light as the central bank dependent investment community is that there is a solid body of opinion in Japan that recognizes that a large part of the country's issue is demographic and that simply "jump starting" a bit of inflation won't make the problem go away..<br />
<br />
The question I would ask is this: given all the doubt which exists about the real roots of Japan's problem, and the fact that it may well be a permanent structural problem and not a temporary liquidity trap one, is it really justified to run such a high risk, all-or-nothing experiment? Even Paul Krugman seems to have changed his assessment various times since the problem started and while he still fully supports the general approach being taken he now thinks the natural rate of interest may remain permanently negative and that <a href="http://krugman.blogs.nytimes.com/2014/04/09/stagnation-without-end-amen-wonkish/?_php=true&_type=blogs&_php=true&_type=blogs&_r=1">fiscal stimulus might be necessary on a permanent basis</a> (liquidity trap without end, amen).
What makes people like me nervous is the thought that if the central bank can't deliver on its promise to deliver inflation, or if the Japanese voters decide they have had enough of the experiment, then a loss of confidence might ensue, and all those dubious risky asset positions might unwind suddenly, just like an earlier set did in 2008.<br />
<br />
And there are plenty of people in Japan who have been pointing this out all along. Seki Obata, a Keio University business school professor for example, who in 2013 published a book "Reflation is Dangerous," argues exactly this, that "Abenomics" is exposing Japan to considerable risk without any clear sense of what it can accomplish. Obata also makes the extremely valid point that there is simply no way incomes can rise across the entire economy because the baby boomers are now retiring to be replaced by fewer young workers with post labour reform entry-level wages. Japan's overall consumer spending power will therefore fall, rather than rise as Abe hopes. "Individual companies may offer wage increases, but because of demographics it is simply impossible to increase the total amount that is paid out in wages," says Obata. "On the contrary, that amount will shrink."
Simple logic you would have thought, but logic in the face of irrational exuberance scarcely stops people in their tracks.<br />
<br />
As far as I can see, all of this points to one simple and evident conclusion: that Japan needs deep seated cultural changes, especially ones directed to greater female empowerment and more open-ness towards immigration. Hardly matters for central bank initiatives, and indeed ones for which Shinzo Abe, who naturally has given his name to this new economic trend, is singularly ill equipped to carry through. Japan needs a series of structural reforms – like those under discussion around the third arrow – but these would be to soften the blow of workforce and population decline, not an attempt to run away from it. Monetary policy has its limits. As Martin Wolf <a href="http://www.ft.com/intl/cms/s/0/b94e6c00-7dd3-11e3-95dd-00144feabdc0.html#axzz34hdetIbk">so aptly put it</a>, "you can't print babies".<br />
<br />
The above is based on arguments fleshed out in much more detail in my "mini book" the A B E of Economics.<br />
<br />
The book is available with Amazon as an e-book. <a href="http://www.amazon.co.uk/gp/product/B00L4KTLDM?*Version*=1&*entries*=0">It can be found here</a>.
You don't need to buy a Kindle to read this book. You can <a href="http://www.amazon.com/gp/feature.html/ref=kcp_pc_ln_ar?docId=1000426311">download a free app from Amazon</a>.<br />
<br />
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Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7336648542166394110.post-73983220424034992062014-07-15T09:12:00.000-07:002014-08-14T10:57:36.111-07:00Spain and the IMF: Round the Bend or Out of the Woods?"Spain has turned the corner". With this stark statement the IMF opened it's annual <a href="http://www.imf.org/external/pubs/ft/scr/2014/cr14192.pdf" target="_blank">Article IV consultation report for 2014</a>. Naturally the statement rankled, with this author among others, because at first sight it seems to be saying something which on closer reading of the report you find it isn't. At best it's misleading, possibly from a PR point of view intentionally so, but then Article IV reports are supposed to be more sober, measured assessments. One Spanish journalist summed up the surprise many felt <a href="https://twitter.com/claudiperez/status/487527958023004160" target="_blank">in the following tweet</a>. <br />
<blockquote class="tr_bq">
Dear IMF,
You can't say "Spain has turned the corner" and "the unemployment remains unacceptably high" in the same paper
It's silly
Yours,
C</blockquote>
What I suppose the authors of the report were trying to convey was the feeling that an important turning point had been passed along the long winding road out of the mess that was generated in Spain in the first seven years of the Euro's existence. Personally I can't help feeling the expression would have been none the less prosaic and much more complete had they added the line from a well know Jimmy Cliff song - yet there are still "many rivers left to cross". Equally, "not through the rapids yet" comes to mind.<br />
<br />
The danger of putting things in the way the IMF Spain team just did is that you open yourself up to the accusation of being complacent, even self-congratulatory, and almost lacking in the necessary even handedness since it could be seen as lending a helping hand to a struggling government which is about to ramp up its 2015 election campaign. Indeed more than one journalist took it this way. <br />
<br />
There's a danger here, one of institutional credibility, should the economy once more succumb and fall back into a triple dip. Indeed the downside risks detailed in the report offer plenty of arguments as to why just that might well happen. In any event this wouldn't be - as Landon Thomas <a href="http://www.nytimes.com/2012/06/27/business/global/spanish-officials-hailed-banks-as-the-crisis-built.html?pagewanted=all&_r=0" target="_blank">pointed out in this article</a> - the first time the Fund has gotten things badly wrong on Spain.<br />
<br />
<b> Fair And Balanced?</b><br />
<br />
The thing is, once you get past that troublesome first phrase, much of the report - leaving aside one or two topics I will draw attention to - seems remarkably unobjectionable. The opening paragraph continues, "Growth has resumed, labor market trends are
improving, the current account is in surplus, banks are healthier, and sovereign yields are at record lows", most of which is unquestionably true.<br />
<br />
And then those positive evaluations are suitably and appropriately counterbalanced by a string negatives, "But unemployment is unacceptably high, incomes have fallen,
trend productivity growth is low, and the deleveraging of high debt burdens—public and private—is weighing on growth".<br />
<br />
So actually the fund isn't at all saying that all is well in Spain, and that the level 5 alert is now all but over - far from it. Perhaps an opening phrase more in tenor with the general drift would have been "Spain's recovery continues to gain traction".<br />
<br />
<b>Export Lead Recovery?</b><br />
<br />
As I say, most of the positive assessment offered is valid. Most, but not all. There is one exception: the state of the current account. It is no longer positive.<br />
<br />
Surely it is true to say, as the authors do, that "Spain has managed a remarkable improvement in its current account". During the last 5 years the balance improved by 11 percent of GDP, moving from a deficit of 10 percent in 2007 to a 1 percent surplus in 2013. But that was then, and this is now, and as the recovery has progressed part of the improvement has been lost. During the 8 months between May and December 2013 the account was in positive territory. 8 months in something like the last 150. For each of the five months of 2014 however - just as the economy has been accelerating - it has been consistently negative. Indeed the fact this might happen was expressed as a constant concern in earlier editions of the report (namely, that as things improved the CA balance would once more turn negative). Now it has, which is perhaps one of the reasons why they were ill-advised to use that "corner turning" phrase.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiJQX3f-U5V4_l8W9X_ABPgglUHI-zEAqJZjbTPW0iQtyrDgOn-SE5tpw6xGFiMS8CbMTbfGGFjqt10MXZPadM0o82mhEp7MS2ZrjZfqr24wIc2NEw-4PpGYUQMwbgrU0xa5dAUYquhOyE/s1600/current+account+balance.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiJQX3f-U5V4_l8W9X_ABPgglUHI-zEAqJZjbTPW0iQtyrDgOn-SE5tpw6xGFiMS8CbMTbfGGFjqt10MXZPadM0o82mhEp7MS2ZrjZfqr24wIc2NEw-4PpGYUQMwbgrU0xa5dAUYquhOyE/s1600/current+account+balance.png" height="171" width="320" /></a></div>
<br />
As the Fund points out, only one other advanced large non-commodity exporting country has managed to achieve a current account improvement of a similar order, and that was South Korea in 1997–98 (so comparisons and precedents here are few and far between), and the key factor in the Korean case was the ability to devalue the Won. As the Fund says:<br />
<blockquote class="tr_bq">
"Spain’s current account improvement is particularly notable given that it was achieved without nominal depreciation. South Korea’s adjustment was facilitated by a large nominal exchange rate depreciation, an option that was not available to Spain. While Spain’s real effective exchange rate (REER) did depreciate significantly based on unit labor costs, it largely reflected labor shedding. The CPI-based REER has not depreciated much."</blockquote>
What the authors are getting at here is that Spain's nominal internal devaluation was very small, and indeed the overwhelming majority of Spanish experts have consistently argued that more wasn't needed since the economy hadn't lost as much competitiveness as "outsiders" claimed. On the other hand there was a large improvement in Unit Labour Costs produced by the comparatively small fall in GDP output (roughly 7%) and the very large drop in the number of those working (about 20%), but this way of doing things always left the concern that as the economy started creating jobs again the average Unit Labour Cost would start to rise again, as we have seen happen in Ireland (see chart below).<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgnrG3-7TB9dNA2eJgG-T_11Ssy2-KroQKrKocNe8LPPJSwI8ko61OgoCmN8r2mD4tEkivRxjI1XLNC7oDoOuf8F7EWZ4FdOyNTY0Mizpm2st7Pu0pB9M061fky6OU4a1h9TYtbaqkYPng/s1600/2014-07-13_115057.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgnrG3-7TB9dNA2eJgG-T_11Ssy2-KroQKrKocNe8LPPJSwI8ko61OgoCmN8r2mD4tEkivRxjI1XLNC7oDoOuf8F7EWZ4FdOyNTY0Mizpm2st7Pu0pB9M061fky6OU4a1h9TYtbaqkYPng/s1600/2014-07-13_115057.png" height="229" width="320" /></a></div>
<br />
In fact there is even some indication that this may already be happening. In the 12 months to March the economy grew by 0.6% while the number of those paying national insurance contributions (a reasonable proxy for employment) rose by 115,000 (or 0.7%). As a result the rate of productivity improvement has declined sharply.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhM5WG4-ISJrmYCUPhCJguGmB_p6m7dLX3mhBwcpgPpNqRr9Yg77fhhuTvfvQ6E-H7Y9ksWTETMSQhCnLEtv1VVqLefZ17vWPG-0vuOyIABpDwsOpQ6c7vTm33XfFBp6svC2GO0GQwE9KE/s1600/Spain+productivity.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhM5WG4-ISJrmYCUPhCJguGmB_p6m7dLX3mhBwcpgPpNqRr9Yg77fhhuTvfvQ6E-H7Y9ksWTETMSQhCnLEtv1VVqLefZ17vWPG-0vuOyIABpDwsOpQ6c7vTm33XfFBp6svC2GO0GQwE9KE/s1600/Spain+productivity.png" height="180" width="320" /></a></div>
<br />
The danger thus is that many of the hard won gains of the crisis years are unwound during recovery. The current account deficit fell sharply on the back of the drop sharp drop in employment which accompanied the crisis as consumption collapsed (retail sales are still down 30% from 2007 peak) and imports followed suit. Little by little this process is now reversing, imports are once more rising as domestic consumption starts to recover and the goods trade surplus is once more deteriorating.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj35zcgvsPUtiCM-4SBdH5Agbfxb8BbXCxWDUu7tu4ra6sSd2AZW_jjeZvRIlbl5AloCHZaCI8qxiEmGWn6WIfh7epYuFHJT57iyxmSBxKbBBqYthbJCXvBNqDgbKp2qphX957HuJEB9GI/s1600/W+Bank+of+Spain+Goods+deficit.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj35zcgvsPUtiCM-4SBdH5Agbfxb8BbXCxWDUu7tu4ra6sSd2AZW_jjeZvRIlbl5AloCHZaCI8qxiEmGWn6WIfh7epYuFHJT57iyxmSBxKbBBqYthbJCXvBNqDgbKp2qphX957HuJEB9GI/s1600/W+Bank+of+Spain+Goods+deficit.png" height="182" width="320" /></a></div>
<br />
So the correction is far from complete at this point and the risk the corner has been not been completely turned is not negligible. Which bring me to another minor quibble with this section of the report. "Exports are performing well," the authors tell us. Well perhaps the best thing that can be said about this statement is that it is a little bit out of date. In the three months to May Spain's goods exports were up by 2.75% over the same period a year earlier. In comparison in 2013 they were up by 6.5%. Spain's export machine has been losing momentum, and - <a href="http://edwardhughtoo.blogspot.com.es/2014/04/spain-land-where-incipient-deflation.html" target="_blank">as I argue in this post</a> -exports are now roughly stuck at the level they were at in June last year. Naturally there are reasons for this, emerging markets who were strong Spanish customers last year have had their own crisis, and now tensions in Eastern Europe surrounding Ukraine may be leading the Euro Area itself to loose momentum. But this is just it, a fragile and tenuous recovery is easily knocked off balance.<br />
<br />
The current position can perhaps be best summed up by the situation described in the chart below. Between 2010 and 2013 the economy was re-balancing nicely with external demand doing the heavy lifting while the current account moved towards balance, but over the last twelve months things have changed and external demand is now, once more, a negative drag on the economy as imports rise. This is obviously a worrying development, and naturally a cause for concern.<br />
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<br />
Indeed the authors of the IMF report more or less implicitly accept that the external correction is far from complete when they say:<br />
<blockquote class="tr_bq">
"Model-based and historical REER analysis suggests the real effective exchange rate is some 5–
15 percent above the level consistent with medium-term fundamentals and desirable policies. However,
achieving significantly lower unemployment rates closer to international peers in the medium term may
require an even larger adjustment in the exchange rate".
</blockquote>
<b>What Does Unacceptably Mean?</b><br />
<br />
I think we are all in agreement on one thing: Spain's unemployment remains unacceptably high. But what does "unacceptable" mean? Well normally it means you don't continue to accept it and do something about it. And this is just the part I find missing from this year's IMF report.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj-HD5sV0uMoioP8dP6xRHaTLQwCPijQMkRNfw7K5A2BdbODc2CC6fQJ3DxTvKTwnpIa361swZiZ0N-QlNTDkAntBDaCocYuSlaD4_CV1z_yHEKNoCfzrriMJpaPUkaq-dc869rA9QNp4Y/s1600/unemployment+one.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj-HD5sV0uMoioP8dP6xRHaTLQwCPijQMkRNfw7K5A2BdbODc2CC6fQJ3DxTvKTwnpIa361swZiZ0N-QlNTDkAntBDaCocYuSlaD4_CV1z_yHEKNoCfzrriMJpaPUkaq-dc869rA9QNp4Y/s1600/unemployment+one.png" height="172" width="320" /></a></div>
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If we go back twelve months, and take a look at last years report, then it's easy to notice a clear difference: the IMF offered a proposal for <b>doing</b> something. Essentially the proposal, which naturally was not at all popular in Spain, was to move towards a wage cut in return for job sharing (indeed I myself agreed with this proposal - see my "<a href="http://spaineconomy.blogspot.com.es/2013/09/doing-nothing-is-not-option.html" target="_blank">Doing Nothing Is Not An Option</a>", and even wrote a chapter arguing for it in my <a href="http://www.amazon.es/%C2%BFAdi%C3%B3s-crisis-superado-recesi%C3%B3n-recuperaci%C3%B3n/dp/8423418510/ref=sr_1_1?ie=UTF8&qid=1395218690&sr=8-1&keywords=edward+hugh" target="_blank">Spanish book on Spain</a>).<br />
<br />
Another possibility, which I have personally advanced inside Spain, would be to temporarily change the retirement regulations to allow people to retire from 60 onwards on the condition that their employer replaces them with someone previously unemployed and under 30 (not obviously job for job) on a long term contract.<br />
<br />
Now, you will say, doesn't this roll back the 2010 pension reform which tied retirement ages to life expectancy and saw a progressive increase in retirement age from 65 to 67? This reform was much applauded at the time, and was indeed a core part of the Zapatero government's attempt to regain market credibility. My response to this objection is, indeed it would, but lets think about the situation for a moment, and in particular about the meaning of Keynes's oft over-cited phrase, "in the long run we are all dead". What Keynes is getting at here is that we need to be "nimble of thought" enough to be able to distinguish between the different time horizons involved in economic policy. (And not simply shrug our shoulders because "in the long run it will all sort itself out). Simply because something is advantageous in the long run, doesn't mean that a policy to promote it is what is needed in the shorter term. There can be a trade-off of interests, and doing something which might be harmful in the longer run (running up government debt), could be not only a palliative in the short run but could lead to a superior long run outcome if it is done wisely. The dilemma we face in Spain was summed up in more theoretical terms by the founder of modern growth theory - Robert Solow - when he admitted in his <a href="http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1987/solow-lecture.html" target="_blank">Nobel acceptance speech</a>, that "the problem of combining long-run and short-run macroeconomics has still not been solved".<br />
<br />
In the long run, despite the fact that we will all die, we are all living longer, and having longer working lives makes sense. But in the short run, in a country with 5.9 million people unemployed (half of them for over a year) and over 50% of those between 16 and 24 who are looking for work unable to find it, asking people to work longer doesn't seem to make that much sense. <br />
<br />
Letting people retire to be replaced by people with a younger mindset makes obvious economic and productivity sense, but what about the implications of such a decision for the pensions system? Wouldn't this be moving backwards? Well this is where the second (2013) pension reform comes in. That reform introduced the principle of "sustainability" into the Spanish pension system. Sustainability means - across the economic cycle - as much money needs to come in as goes out. I think this is a good reform, indeed a vital one, since it turns Spanish pensions from being a defined benefits system (which would be unable to live up to its promise) into an easy to understand defined contributions one. The pension system becomes an implicit contract between those working and those receiving benefits and takes the government (and most importantly its finances) out of the middle. There is a formula to decide how much can be paid in any given time period, so if more people suddenly start claiming pensions naturally pensions will go down proportionately, but there is no system to collapse, and there will be no knock on effect on government finances.<br />
<br />
What both these proposals have in common is that they involve solidarity and they involve sacrifice, and neither of these seem to be very much in fashion at the moment. But people need to be aware of the <b>longer run consequences of doing nothing</b>. And this is just where expressions like "Spain has turned the corner" don't really help, since they don't put people in the right frame of mind. If unemployment <b>is</b> unacceptably high then it is an urgent matter to do something more about it, and not just sit there with our arms folded to see if the IMF forecast of unemployment moving under 20% in 2019 is fulfilled or whether it happens in 2018, or 2020. These kind of outcomes simply won't do, and as we will see below they will have long run consequences for Spain.<br />
<br />
<b>Long Run Growth Potential</b><br />
<br />
I think virtually everybody agrees that the Spanish economy will grow this year at a rate lying somewhere between 1% and 2%. Naturally a lot of debate and energy has been invested in arguing about just which end of the range will be nearer the final mark. The end result, whatever it is, will be better than expected six months or so ago but at the same time it will hardly constitute an economic revolution. No game changer to see here, please move along.<br />
<br />
The issue is really what we can expect from Spain in the years ahead, well beyond 2014 and 2015, and in approaching that tricky question there is no piece of current economic data that can help us decide. We need a different approach: growth analysis.<br />
<br />
To put things into some sort of perspective on this account it is worth perhaps noting Spanish retail sales were up a mere 0.3% in the three months through May over the same period a year earlier, while industrial output was up around 2.5% over the same time horizon. The notable difference between these two numbers reflects the fact that at the end of the day the future of Spain's economy is now more linked to the sale of industrial products abroad than it is to the level of shop sales at home. But the second thought to take away is the sobering one that both of these indicators are still down around 30% since 2007, and that at current rates the economy will need over a decade to get them back to earlier levels, if it ever does.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJsLYwB22mOkovr3Oe_Yn8yuaLdkVDWYZiRDJXf05MJg12qq-qOnLzQc1p1khvH0Wv3745MadEiQ6G1OAPpBEfXEutfBcnoGtVWPGZGQtV87-kXPaTCTBkzmk68EXIcVRNwekXiImKN70/s1600/retail+sales.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJsLYwB22mOkovr3Oe_Yn8yuaLdkVDWYZiRDJXf05MJg12qq-qOnLzQc1p1khvH0Wv3745MadEiQ6G1OAPpBEfXEutfBcnoGtVWPGZGQtV87-kXPaTCTBkzmk68EXIcVRNwekXiImKN70/s1600/retail+sales.png" height="192" width="320" /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJ0ySilPwbSLudPDaTRT8_YRSMhTINoWsPNoIEdD-pXHwaJ3wf1TzwVA67zTuFZKlLWA1epc3cwTnex8JK9c1-LOvwYPfNR5_-xK8VAdSUwtf8xiR1cUADmW6h61ZvY8ekOvTB0rC7vBs/s1600/industrial+output.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJ0ySilPwbSLudPDaTRT8_YRSMhTINoWsPNoIEdD-pXHwaJ3wf1TzwVA67zTuFZKlLWA1epc3cwTnex8JK9c1-LOvwYPfNR5_-xK8VAdSUwtf8xiR1cUADmW6h61ZvY8ekOvTB0rC7vBs/s1600/industrial+output.png" height="178" width="320" /></a></div>
<br />
I say *if* it ever does, since a clear possibility exists we may not <b>ever</b> see Spanish retail sales activity in getting back to their earlier pre-crisis highs. The reasoning behind this idea is simple: after rising rapidly in the first decade of the century Spain's population is now falling and aging at quite a rapid rate, and if that rate isn't at least slowed then a decade from now (whatever the reform progress the country makes) it is hard to see the Spanish economy eking out a hell of a lot in the way of growth. Which means if we don't hit those pre-crisis levels soon, which we surely won't, we may never do so - a more thorough explanation of the justification for this (for many perhaps surprising) assertion can be found in my <a href="http://edwardhughtoo.blogspot.com.es/2014/06/secular-stagnation-part-1-paul-krugmans.html" target="_blank">Secular Stagnation Part 1 - Paul Krugman's Bicycling Problem</a>).<br />
<br />
What we need to think about then are not the country's short-term economic dynamics, but its growth potential in the longer term. On this issue the recent report <b>does</b> indeed have something to say (and what it says is backed-up by a deeper analysis in the 2014 edition of <a href="http://www.imf.org/external/pubs/ft/scr/2014/cr14193.pdf" target="_blank">Spain Selected Issues</a>). The authors of the Article IV report tell us the following:<br />
<blockquote class="tr_bq">
"Longer-term potential growth prospects also appear weaker than in the boom years. Growth during 1995–2007 was sustained by large accumulation of capital (the credit-fuelled housing boom) and labor (immigration and rising participation rates) hiding a substantial decline in productivity growth. Demographic trends have now turned negative (emigration and the ageing population) and capital accumulation will likely be lower (given the large rise during the boom and falling population). Spain will also need to tackle the negative effects of very high structural unemployment. <b>In this context, potential growth may only be around 1 percent over the medium term</b>."</blockquote>
<br />
They back up the idea that Spain's longer term growth outlook (as opposed to short term recovery-from-the-slump growth) is moving steadily lower with the help of the nice chart I reproduce below.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-_ZXFw-eFvKl2vB0mrFJAI3Ep890gUn4oLMRXz6JIAyiy6AGBOh56t9Ujvz4pRf2taheyaV1a5PIWmZ7yALbZgj2-MCkiGe4a1CTKUK0zZBcn3PGQQpc0ppBJ70DvVYPwmZFlux-ZA4c/s1600/2014-07-15_105701.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-_ZXFw-eFvKl2vB0mrFJAI3Ep890gUn4oLMRXz6JIAyiy6AGBOh56t9Ujvz4pRf2taheyaV1a5PIWmZ7yALbZgj2-MCkiGe4a1CTKUK0zZBcn3PGQQpc0ppBJ70DvVYPwmZFlux-ZA4c/s1600/2014-07-15_105701.png" height="231" width="320" /></a></div>
<br />
Over time Spain's growth rate is falling, as it has been in most developed economies. In the Spanish case while the economy grew by an average of 3.5% a year between 1995 and 2007 there was an important structural shift taking place. The rate of per capita GDP growth slump dramatically after 2000 as the employed population surged and <b>much of the growth became labour intensive</b>, a point which is illustrated nicely by another IMF chart:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgaY_rR2t9UAqovxNuVjs8eIGG3MPzTrjVaapiGlyCrO1BLbXX4ew_w6K7SCaP7mR6QerhWtUYHwhLOO6BARx1CDlUTDrPew8-jHHrTN9xJSm6UsvduTxAKruu_oTXNLdCR32xes5VltkA/s1600/2014-07-15_110600.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgaY_rR2t9UAqovxNuVjs8eIGG3MPzTrjVaapiGlyCrO1BLbXX4ew_w6K7SCaP7mR6QerhWtUYHwhLOO6BARx1CDlUTDrPew8-jHHrTN9xJSm6UsvduTxAKruu_oTXNLdCR32xes5VltkA/s1600/2014-07-15_110600.png" height="146" width="320" /></a></div>
Before the mid 1990s a significant part of Spain's growth had come from productivity improvements. Even in the second half of the nineties this remained to some extent the case. But between 2000 and 2007 the red markers almost completely disappear from the chart and as can be readily seen from the chart growth was almost entirely explained by increases in the capital stock (the result of construction activity) and higher labour force growth. This is not the direction a country which wishes to raise its living standards by engaging in higher value added work wants to go.<br />
<br />
Now, in the wake of the crisis, the country faces an enormous challenge since it has to start raising average productivity at the same time as it tries to put 3 million low skilled workers back to work. We have noted above that Spain has been creating employment on much lower than expected GDP growth, this is only partly good news, since the other side of the coin is that productivity improvements (see the red markers in 2012/13) are now slowing. This is what many feared might happen (current again deficit turn negative, productivity gains weaken) and is a warning signal that the current recovery may not be on such solid ground as some imagine.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh276kluktAgQLeC7JbylYf5vK09JoVm9-vQ57Ay_5eHPrKzcL1LSJfkxg12Cf6Hrmr9vE861zv7ySayLVHEGAYduzsLuT9j0S35O73IKsGvohcSJ3GWbtapU61VV2eJbPare3sJ9lOXNc/s1600/Spain+productivity.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh276kluktAgQLeC7JbylYf5vK09JoVm9-vQ57Ay_5eHPrKzcL1LSJfkxg12Cf6Hrmr9vE861zv7ySayLVHEGAYduzsLuT9j0S35O73IKsGvohcSJ3GWbtapU61VV2eJbPare3sJ9lOXNc/s1600/Spain+productivity.png" height="180" width="320" /></a></div>
<br />
But moving beyond the present, the reason we can expect this ongoing fall in trend growth rate to continue has to do with the composition of growth and how trend growth is estimated. Basically long term growth potential is a function of working age population dynamics and total factor productivity (TFP) growth, as shown in the diagram below which illustrates the version of the approach used by the EU commission.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj75Dm6L8mcjp1wrfH2JMxslv8YqJ6GCjP2_c8JN1otu1YCyQMkGiiHl-yO7VkRYEuPDzGnOvwDQs_eJ6lgJ-9K_YlEfpRBQvat3cqMpj6Ta5NKYQO63xYdUAwgRGIsM_8lQ8r9ya0XNiIb/s1600/Latvia+Output+Gap+Model.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj75Dm6L8mcjp1wrfH2JMxslv8YqJ6GCjP2_c8JN1otu1YCyQMkGiiHl-yO7VkRYEuPDzGnOvwDQs_eJ6lgJ-9K_YlEfpRBQvat3cqMpj6Ta5NKYQO63xYdUAwgRGIsM_8lQ8r9ya0XNiIb/s320/Latvia+Output+Gap+Model.png" height="244" width="320" /></a></div>
<br />
Leaving immigration and emigration aside for a moment, Spain's population is now virtually stagnant, fertility is around 1.3 (tfr) and the annual balance will soon turn negative. The annual number of births had been rising before the crisis, but has now started falling again (see chart from statistics office below). <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgQlwbgNumlv0nuu6HrkijsMElH1DluMkM5roEwdeGHx4_PB6Z3EaVKnRyC4xwtPJe6oNCykv1k9JfEoNUPu6SGK8UoI24BpB75fHreK-wQhBReezAmhinzZdb4DHC2GxXYSi-z3DTjFSk/s1600/2014-07-14_160507.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgQlwbgNumlv0nuu6HrkijsMElH1DluMkM5roEwdeGHx4_PB6Z3EaVKnRyC4xwtPJe6oNCykv1k9JfEoNUPu6SGK8UoI24BpB75fHreK-wQhBReezAmhinzZdb4DHC2GxXYSi-z3DTjFSk/s1600/2014-07-14_160507.png" height="146" width="320" /></a></div>
<br />
The annual balance between births and deaths also rose to a peak in the boom years only to subsequently fall back (see chart below). In fact the difference between births and deaths was a record low of 36,181 in 2013, and within a few years the balance will surely be negative. But again we need to remember, in economic growth terms it isn't the size of the population that matters, it is the age structure, and Spain's working age population will certainly shrink faster than the overall population will. So even on the best of scenarios Spain's workforce is now facing slow and steady decline and this will undoubtedly bring down the trend growth performance.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdTWs-HdyPvnfcfGCPt8ZcXuXvOwLRRJC_zMtCjKmIedEb3f0W71Zf0c2HezKDbpXh5obKUur02hZUMzNFTsfjgZflZRgC18gUYkAnC0iu6GZoo5VtbSMWjK7AtpVHyv69UYMYiev0aic/s1600/2014-07-14_160948.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdTWs-HdyPvnfcfGCPt8ZcXuXvOwLRRJC_zMtCjKmIedEb3f0W71Zf0c2HezKDbpXh5obKUur02hZUMzNFTsfjgZflZRgC18gUYkAnC0iu6GZoo5VtbSMWjK7AtpVHyv69UYMYiev0aic/s1600/2014-07-14_160948.png" height="151" width="320" /></a></div>
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<br />
But Spain isn't facing the best of scenarios. Where once people were arriving, the dire state of the country's labour market means they are now leaving. And once we factor in immigration, things start to get a bit more dramatic. As the IMF notes (in the <a href="http://www.imf.org/external/pubs/ft/scr/2014/cr14193.pdf" target="_blank">2014 selected issues document</a>):<br />
<blockquote class="tr_bq">
"Demographics have turned negative. After expanding at a fast pace until 2007, population growth slowed significantly and turned negative in 2012. This is likely to be a new trend, as INE projects working-age population to continue to decline over the next years........Labor dynamics will make a much weaker contribution to potential output. Demographics will be a drag on growth due to declining working-age population (emigration and ageing). The Spanish statistical agency (INE) expects working-age population to fall by 1 percent a year over the medium term." </blockquote>
During the boom years over nearly 6 million immigrants came to live or work in Spain. The population - which as we have seen is nearly stationary in terms of births minus deaths - shot up from 40 to 46 million. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi9BzHn_0dPhb-ksv0TVjyBeiJf2ZYroFucHZrLvVebmys2sB976dLtFXzisPO65ekaWI1Cn4Ong6zi-hhUX4I71Vv-xnf_6Psu6Alddh7YtFJ44k_XGGJqUVRYiaj5J75n6LWpOHJjPAg/s1600/spain+immigrants.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi9BzHn_0dPhb-ksv0TVjyBeiJf2ZYroFucHZrLvVebmys2sB976dLtFXzisPO65ekaWI1Cn4Ong6zi-hhUX4I71Vv-xnf_6Psu6Alddh7YtFJ44k_XGGJqUVRYiaj5J75n6LWpOHJjPAg/s1600/spain+immigrants.png" height="174" width="320" /></a></div>
<br />
But now, as the IMF say, this dynamic has turned negative. Quite how many people of working age are leaving Spain every year is hard to say. This, in part, is because while the number of former immigrants leaving is known with a reasonable degree of accuracy, the number of young Spanish nationals who do so is much harder to pin down, in part because you need to go to receiving countries like the UK and Germany to obtain the data since most Spaniards who are working abroad have not registered with the national authorities.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZsem9T4yOsnY69HUwmfe2z-VyA-hMK1XnK3fAKllazzxJZLyuqm4ynRzk0s3yvQX12Yy0vY4dZv4vLG2c1v62AyGqjsfk7wG1bFukMoHPD9a3rvNAUUKJDtGjimFCa5Qhd3v4cQ0K24g/s1600/Spain+NI+numbers+in+the+UK.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZsem9T4yOsnY69HUwmfe2z-VyA-hMK1XnK3fAKllazzxJZLyuqm4ynRzk0s3yvQX12Yy0vY4dZv4vLG2c1v62AyGqjsfk7wG1bFukMoHPD9a3rvNAUUKJDtGjimFCa5Qhd3v4cQ0K24g/s1600/Spain+NI+numbers+in+the+UK.png" height="179" width="320" /></a></div>
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According to the latest estimates (30 June 2014) the net number of emigrants leaving Spain in 2013 was 256,849. Of these the net number of Spanish nationals leaving was 45,913. But this latter number is confusing since during 2013 some 190,000 former immigrants obtained Spanish nationality and some of these subsequently left for other EU countries. More to the point perhaps, is that these are net numbers. The gross numbers are even more shocking: over half a million people left Spain in 2013 (547,890 to be exact), while some 291,041 new immigrants arrived.<br />
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Now I don't want to get into the issue of the enormous tragedy that is taking place daily on Europe's southern borders (and in any event many of the newcomers currently arriving in Spain are doing so as part of family regroupment processes) but the absolute number of people leaving is very large, and those leaving possess a skill set which is vastly superior to that of those arriving, so in the longer run the human capital drain on Spain is massive, again reducing the potential longer term growth rate. As the IMF point out, projections here are pretty risky, but still the Spanish statistics office (INE) have made an attempt, and the result can be seen in the table below.<br />
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The impact of this hemorrhage (if it is confirmed over time) on Spain's population pyramid will look something like this.<br />
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Basically Spain's population will suddenly have become<b> much smaller and much older</b>. The population will fall by 2.6 million, and the number of people in the 20 to 49 age group <b>will fall by 4.7 million</b> (or 22.7%). This is why it is so important to try to do something more and boost employment rapidly. Otherwise the impact on long term growth will be sizable, and the pressure to reduce pensions constant. This INE population and emigration forecast is, if you like, based on a no policy change assumption, on what will probably happen unless substantially more is done. It is the sense of urgency about this need to do something more that I - and others - do not find encapsulated in the phrase "Spain has turned the corner". If these population projections are realized then quite simply it won't have done so. Pensions, for one thing, will be set on a continuously downward path, which is why I think pensioners could be convinced of the need for them to make sacrifices now, if the situation were better explained to them. For another the debt which is currently accumulating will have fewer and fewer people left to pay it. And lets not even start talking about the impact of this sharp reduction on the value of Spanish property.<br />
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The real problem in Spain - and this issue isn't treated in the report - is the complete collapse of civic confidence in many of Spain's institutions, from the Bank of Spain, to market regulator CNMV (the Bankia IPO, Preference Shares), to politicians and political parties (the Barcenas affair, among many others), to the monarchy. It is this crisis of confidence which makes it so difficult to get the consensus to make more sacrifices.<br />
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Many say that there can't possibly be 25% unemployment in Spain since if there were there would be a revolution (referring to the existence of the underground economy but conveniently forgetting that the worst years of the 1930s depression were not years of revolution, those came later).<br />
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What people are missing about Spain is the way the credibility of the institutional structure is weakening. Voices talking about a constitutional crisis are growing. The economic crisis basically coincided with the moment when the set up established - including the return of the monarchy - during the transition from Franco's dictatorship to democracy was increasingly seen as having "run its course". Many observers recognise that major constitutional reform is needed and some kind of "rebirth" and renovation in the political system. Last months EU elections were the latest warning signal. The two main political parties (the so called institutional parties) for the first time since the transition failed to get over 50% of the popular vote between them, while the Syriza-like Podemos - who hadn't even been listed in the opinion surveys - surged from nowhere to take 5 seats and 9% of the vote. And in Catalonia a large majority of voters voted for parties who are actively campaigning for independence from Spain. A general election is coming next year, but it is hard to see either of the "old" parties getting a majority without a complex set of coalition partners.<br />
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So rather than asking whether Spain has now gone round the bend perhaps the Fund would have been better off sticking with "Getting better, but not out of the woods yet, not by a long way".Unknownnoreply@blogger.com0