Friday, September 23, 2016

23/9/16: The Future of Work: Uncharted Policy Waters

My presentation on economic and social challenges of the emerging Gig-economy (contingent workforce) from earlier this year:

23/9/16: Two Major Partnerships for AID:Tech

AID:Tech CEO, Joseph Thompson presented at the Techstars Demo Day earlier this week.

Here is the video of his excellent talk about AID:Tech-powered technology promise to the aid and development sector: delivered in front of some 600 top European technology VCs and business development specialists.

As a part of the Demo Day, AID:Tech also made two new partnerships announcements. Details are here:

As a board member and an adviser to the company, I am proud of what the team led by Joseph have been able to achieve within a span of just few months. The importance of blockchain-based solutions in providing greater efficiencies, better security and higher degree of transparency to payments in the international aid and development area is matched by the blockchain potential to revolutionise  key development sub-sectors of micro-lending and micro-insurance. AID:Tech are clearly positioned to lead fintech innovation in these market niches.

Wednesday, September 21, 2016

21/9/16: BOJ New (non) Bazuka

21/9/16: Apple Tax Case: Not the Rate, the Loopholes

My column for the Village covering the Apple Tax fiasco:

As it says on the 'tin' - the problem with Apple Tax is not the rate of corporate taxation set in law in Ireland (the 12.5% 'red line' rate), and not tax competition, nor the benign nature of tax exemptions that Ireland bestows on all companies, including the MNCs. The problem is that these competitive aspects of the Irish regime are simply not enough for the likes of Apple, which pursued and obtained access to exemptions that any ordinary company operating in Ireland cannot avail of.

Hence, the red herring of the arguments that the EU Competition ruling is an attack on Irish tax rate. It is, instead, a challenge to the asymmetric preferences granted in the past (and still in use during the ongoing phase-out period) to a handful of MNCs over and above domestic companies. Lest we forget, for decades, Irish State had no qualms operating an openly discriminatory taxation regime that treated foreign investment-backed companies differently from domestic companies. Lest we omit considering the present, Irish State still has no qualms taxing human capital of its residents at rates far in excess of those applying to physical and financial capital. Lest we fail to think about it, Irish State has no qualms asymmetrically allocating the burden of the crisis to Irish people over and above our banks, foreign investors, foreign bondholders and vulture funds.

I am one of the most vocal advocates of low (benign) taxation, flat tax, competitive regulatory regimes (coupled with robust enforcement) and other means for improving the functioning of the private markets. Always been one and remain. I support real investment in the economy, both foreign and domestic and believe in a level playing field for entrepreneurs and enterprises, alike. But, folks, the debate around Apple Tax is not about 12.5% tax rate and Ireland's tax autonomy, but about asymmetric nature of privilege.

22/9/16: The most important charts in the world... BusinessInsider

BusinessInsider published their new set of "The most important charts in the world from the brightest minds on Wall Street" :

My - as always contrarian and, hence, somewhat optimistic - contribution here:

21/9/16: BOJ & Fed: Surprises at the End of Policy Line?

My comment for Portugal's Expresso on Bank of Japan and U.S. Fed rate setting meetings (comment prior to both):

English version:

With Bank of Japan clearly running out of assets to buy to sustain its continued efforts to further ease money supply, the Bank’s September 20th meeting is likely to be more significant from the markets perspective than the Fed’s. Back in July, Bank of Japan initiated a comprehensive review of its current policy measures. This move was based on two key pressures faced by Tokyo: the complete lack of monetary policy effectiveness and the shortages of assets eligible for BOJ purchases, still remaining in the markets.

My suspicion is that BOJ is likely to go for the reversal of the Fed’s Operation Twist, buying - as Washington did in 1961 and 2011 - shorter maturity bonds. In 2011, the Fed opted to buy longer-term debt and selling short term bonds. The Fed objective back then was to flatten the yield curve. Bank of Japan today is more desperate to see steepening in maturity curve instead. Paired with deeper foray into negative deposit rates territory, such an Inverse Twist move is probably the likeliest outrun of the current BOJ policy debate, with both policy changes carrying a probability of around 60-70 percent for September 20th meeting. On a longer odds side, expansion of volumes of purchases of bonds (doing more of the same option) for BOJ, in my opinion carries a probability of just 30-40 percent.

BOJ announcement of new policies is potentially more important to the global markets than the Fed’s, in the short run, because BOJ policy options are pretty much similar to those of the ECB, and because Tokyo faces a greater urgency to move this time around. Across the bonds markets, in recent months, there has been an increasing sense that ultra-aggressive monetary policies (those led by BOJ and ECB) have lost their effectiveness just at the time when the central bankers are rapidly running out of option to produce further monetary stimulus without engaging in an outright helicopter money creation. At the same time, as monetary policy effectiveness declined, markets reliance on central banks pumping more and more liquidity into the global financial system is rising as economic fundamentals stubbornly refusing to support current markets valuations in both equities and bonds.

Fed’s rate setting meeting, coming hours after Bank of Japan’s one, will be less predictable and has the capacity to take markets off guard. Prevailing market consensus is that the Fed will simply amplify its extremely moderate hawkish position, signalling once again the growing consensus toward a rate rise after the November Presidential election. In my view, this is the most probable outrun with a probability of around 75 percent. However, given the signs of strengthening economy over 3Q 2016, and the early indications of improving inflationary outlook on foot of August figures, the Fed might surprise with a 25 bps hike in base rates - a low probability (roughly 25%) event. On the ‘hold policy’ side, there has been some disappointing recent economic releases, with a decline in retail sales, flat producer prices inflation and a large drop in industrial production. These, alongside the political cycle, weigh heavily on the probability of a rate hike this week.

The key to the September rates outlook and the markets dynamics will be the twin combination of BOJ and Fed moves. Dovish Fed, alongside further aggressive expansion of Japan’s monetary policy will serve as a forward signal for the ECB to boost its own asset purchasing programme. This is a more likely outcome of Wednesday news flow, given the conditions in the domestic economies and in the global trade environment. Any surprises on the side of the Fed or BOJ deviating from dovish stands will likely be interpreted by the markets as a trigger for bonds sell-off and will also be negative for share prices.

Tuesday, September 20, 2016

19/9/16: Survivorship Bias Primers

Not formally a case study, but worth flagging early on, especially in the context of our Business Statistics MBAG 8541A course discussion of the weighted averages and stock markets indices.

A major problem with historical data is the presence of survivorship bias that distorts historical averages, unless we weigh companies entering the index by volumes. Even then, there are some issues arising.

Here are few links providing a primer on survivorship bias (we will discuss this in more depth on the class, of course):

19/9/16: Big Data Biases?

A very interesting, and broad (compared to our more statistics-specific discussions in MBAG 8541A) topic is touched in this book: The basic point is: data analytics (from basic descriptive statistics, to inferential statistics, to econometrics and bid data analysis) is subject to all the normal human biases the analysts might possess. The problem, however, is that big data now leads the charge toward behaviour and choice automation.

The book review focuses on ethical dimensions of this problem. There is also a remedial cost dimension - with automated behaviour based on biased algorithms, corrective action cannot take place ex ante automated choice, but only either ex ante analysis (via restricting algorithms) or ex post the algorithm-enabled action takes place. Which, of course, magnifies the costs associated with controlling for biases.

One way or the other - the concept of biased algorithmic models certainly presents some food for thought!

Monday, September 19, 2016

19/9/16: US Median Income Statistics: Losing One's Head in Cheerful Releases

In our Business Statistics MBAG 8541A course, we have been discussing one of the key aspects of descriptive statistics reporting encountered in media, business and official releases: the role that multiple statistics reported on the same subject can have in driving false or misleading interpretation of the underlying environment.

While publishing various metrics for similar / adjoining data is generally fine (in fact, it is a better practice for statistical releases), it is down to the media and analysts to choose which numbers are better suited to describe specific phenomena.

In a recent case, reporting of a range of metrics for U.S. median incomes for 2015 has produced quite a confusion.

Here are some links that explain:

So, as noted on many occasions in our class: if you torture data long enough, it will confess... but as with all forced confessions, the answer you get will bear no robust connection to reality...

19/9/16: FocusEconomics: The Italian Dilemma

Good post from FocusEconomics on the saga of Italian banking crisis:

And an infographic from the same on the scale of the Italian banking woes:
Click to enlarge

It is worth noting that in the Italian banking case, asset quality crisis (NPLs etc) and compressed bonds returns (yield-related income decline due to ECB QE) are coinciding with elevated macroeconomic risks, as noted by the Tier-3 ranking for Italy in Euromoney Country Risk surveys:

Saturday, September 17, 2016

17/9/16: The Mudslide Cometh for Your Ladder

One chart that really says it all when it comes to the fortunes of the Euro area economy:

And, courtesy of these monetary acrobatics, we now have private corporates issuing debt at negative yields, nominal yields...

The train wreck of monetarist absurdity is now so far out on the wobbly bridge of economic systems devoid of productivity growth, consumer demand growth and capex demand that even the vultures have taken into the skies in anticipation of some juicy carrion. With $16 trillion (at the end of August) in sovereign debt yielding negative and with corporates now being paid to borrow, the idea of the savings-investment link - the fundamental basis of the economy - makes about as much sense today as voodoo does in medicine. Even WSJ noted as much:

Which brings us to the simple point of action: don't buy bonds. Don't buy stocks. Hold defensive assets in stable proportions: gold, silver, land, fishing rights... anything other than the fundamentals-free paper.

As I recently quipped to an asset manager I used to work with:

"A mudslide off this mountain of debt will have to happen in order to correct the excesses built up in recent years. There is too much liquidity mass built into the markets devoid of investment demand, and too weak of an economy holding it. Everywhere. By fundamental metrics of value-added growth and organic demand expansion potential, every economy is simply sick. There is no productivity growth. There is no EPS growth, even with declining S down to waves of buy-outs. There is debt growth, with no capex & no EPS growth to underwrite that debt. There is a global banking system running totally on fumes pumped into it at an ever increasing rate by the Central Banks through direct monetary policies and by indirect means (regulatory shenanigans of ever-shifting capital and assets quality revisions). There is no trade growth. There is no market growth for trade. Neither supply side, nor demand side can hold much more, and countries, like the U.S., have run out of ability to find new lines of credit to inflate their economies. Students - kids! - are now so deep in debt before they even start working, they can't afford rents, let alone homes. Housing shortages & rents inflation are out of control. GenZ and GenY cannot afford renting and paying for groceries, and everyone is pretending that the ‘shared economy’ is a form of salvation when it really is a sign that people can’t pay for that second bedroom and need roommates to cover basic bills. Amidst all of that: 1% is riding high and dragging with it 10% that are public sector ‘heroes’ while bribing the 15% that are the elderly and don't give a damn about the future as long as they can afford their prescriptions. Take kids out of the equation, and the outright net recipients of subsidies and supports, and you have 25-30% of the total population who are carrying all the burden for the rest and are being crushed under debt, taxes and jobs markets that provide shit-for-wages careers. Happy times! Buy S&P. Buy penny stocks. Buy bonds. Buy sovereign debt. Buy risk-free Treasuries… Buy, Buy, Buy we hear from the sell-side. Because if you do not 'buy' you will miss the 'ladder'... Sounds familiar, folks? Right on... just as 2007 battle cry 'Buy Anglo shares' or 2005 call to 'Buy Romanian apartments' because, you know... who wants to miss 'The Ladder'?.."

Tuesday, September 13, 2016

13/9/16: U.S. business investment slump: oil spoil?

Credit Suisse The Financialist recently asked a very important question: How low can U.S. business investment go? The question is really about the core drivers of the U.S. recovery post-GFC.

As The Financialist notes: “Over the last 50 years, there has usually been just one reason that businesses have slashed investment levels for prolonged periods of time—because the economy was down in the dumps.”

There is a handy chart to show this much.

“Not this time”, chimes The Financialist. In fact, “Private, nonresidential fixed investment fell 1.3 percent in real terms over the previous year in the second quarter of 2016, the third consecutive quarterly decline.” This the second time over the last 50 years that this has happened without there being an ongoing recession in the U.S.

Per Credit Suisse, the entire problem is down to oil-linked investment. And in part they are right. Latest figures reported by Bloomberg suggest that oil majors are set to slash USD1 trillion from global investment and spending on exploration and development. This is spread over 6 years: 2015-2020. So, on average, we are looking at roughly USD160 bn in capex and associated expenditure cuts globally, per annum. Roughly 2/3rds of this is down to cuts by the U.S. companies, and roughly 2/3rds of the balance is capex (as opposed to spending). Which brings potential cuts to investment by U.S. firms to around USD70 billion per annum at the upper envelope of estimates.

Incidentally, similar number of impact from oil price slump can be glimpsed from the fact that over 2010-2015, oil companies have issued USD1.2 trillion in debt, most of which is used for funding multi annual investment allocations.

Wait, that is hardly a massively significant number.

Worse, consider shaded areas marking recessions. Notice the ratio of trough to peak recoveries in investment in previous recessions. The average for pre-2007 episode is a 1:3 ratio (per one unit recovery, 3 units growth post-recovery). In the current episode it was (at the peak of the recovery) 1:0.6. Worse yet, notice that in all previous recoveries, save for bubble crisis and most recent Global Financial Crisis, recoveries ended up over-shooting pre-recession level of y/y growth in capex.

Another thing to worry about for 'oil's the devil' school of thought on corporate investment slowdown: slump in oil-related investment should be creating opportunities for investment elsewhere. One example: Norway, where property investments are offsetting fully decline in oil and gas related investment. When oil price drops, consumers and companies enjoy reallocation of resources and purchasing power generated from energy cost savings to other areas of demand and investment. Yet, few analysts can explain why contraction in oil price (and associated drop in oil-related investment) is not fuelling investment boom anywhere else in the economy.

To me, the reason is simple. Investing companies need three key factors to undertake capex:
1) Surplus demand compared to supply;
2) Technological capacity for investment; and
3) Policy and financial environment that is conducive to repatriation of returns from investment.

And guess what, they have none of these in the U.S.

Surplus demand creates pressure factor for investment, as firms face rapidly increasing demand with stable or slowly rising capacity to supply this demand. That is what happens in a normal recovery from a crisis. Unfortunately, we are not in a normal recovery. Consumer and corporate demand are being held down by slow growth in incomes, significant legacy debt burdens on household and corporate balance sheets, and demographics. Amplified sense of post-crisis vulnerability is also contributing to elevated levels of precautionary savings. So there is surplus supply capacity out there and not surplus demand. Which means that firms need less investment and more improvement in existent capital management / utilisation.

Technologically, we are not delivering a hell of a lot of new capacity for investment. Promising future technologies: AI-enabled robotics, 3-D printing, etc are still emerging and are yet to become a full mainstream. These are high risk technologies that are not exactly suited for taking over large scale capex budgets, yet.

Finally, fiscal, monetary and regulatory policies uncertainty is a huge headache across a range of sectors today. And we can add political uncertainty to that too. Take monetary uncertainty alone. We do not know 3-year to 5-year path for U.S. interest rates (policy rates, let alone market rates). Which means we have no decent visibility on the cost of capital forward. And we have a huge legacy debt load sitting across U.S. corporate balance sheets. So current debt levels have unknown forward costs, and future investment levels have unknown forward costs.

Just a few days ago I posted on the latest data involving U.S. corporate earnings ( - the headline says it all: the U.S. corporate environment is getting sicker and sicker by quarter.

Why would anyone invest in this environment? Even if oil is and energy are vastly cheaper than they were before and interest rates vastly lower...

Monday, September 12, 2016

12/9/16: Fiscal Policy in the Age of Debt

In recent years, there has been lots and lots of debates, discussions, arguments and research papers on the perennial topic of fiscal stimulus (aka Keynesian economics) on the recovery. The key concept in all these debates is that of a fiscal multipliers: by how much does an economy expand it the Government spending rises by EUR1 or a given % of GDP.

Surprisingly, little of the debate has focused on a simple set of environmental factors: fiscal stimulus takes place not in a vacuum of environmental conditions, but is coincident with: (a) economies in different stages of fiscal health (high / low deficits, high/low debt levels etc) and (b) economies in different stages of business cycle (expansion or contraction). One recent paper from the World Bank decided to correct for this glaring omission.

“Do Fiscal Multipliers Depend on Fiscal Positions?” by Raju Huidrom, M. Ayhan Kose, Jamus J. Lim and Franziska L. Ohnsorge (Policy Research Working Paper 7724, World Bank) looked at “the relationship between fiscal multipliers and fiscal positions of governments” based on a “large data-set of advanced and developing economies.” The authors deployed methodology that “permits tracing the endogenous relationship between fiscal multipliers and fiscal positions while maintaining enough degrees of freedom to draw sharp inferences.”

The authors report three key findings:

First, the fiscal multipliers depend on fiscal positions: the multipliers tend to be larger when fiscal positions are strong (i.e. when government debt and deficits are low) than weak.” In other words, fiscal expansions work better in case where sovereigns are in better health.

“For instance, our estimates suggest that the long run multiplier can be as big as unity when the  fiscal position is strong but it can turn negative when the fiscal position is weak. A weak fiscal position can undermine fiscal multipliers even during recessions. Consistent with theoretical predictions, we provide empirical evidence suggesting that weak  fiscal positions are associated with smaller multipliers through both a Ricardian channel and an interest rate channel.”

By strong/weak fiscal position, the authors mean low/high sovereign debt to GDP ratio. And they show that fiscal expenditure uplift for higher debt ratio states results in economic waste (negative multipliers) in pro-cyclical spending cases (when fiscal expansion is undertaken at the times of growing economy). Which is important, because most of the ‘stimuli’ take place in such conditions and majority of the arguments in favour of fiscal spending increases happen on foot of rising economic growth (‘spend/invest while you have it’).

Second, these effects are separate and distinct from the impact of the business cycle on
the fiscal multiplier.” Which means that debt/GDP ratio has an impact in terms of strengthening or weakening fiscal policy impact also regardless of the business cycle. Even if fiscal expansion is counter-cyclical (Keynesian in nature, or deployed at the time of a recession), fiscal multipliers (effectiveness of fiscal policy) are weaker whenever the debt/GDP ratio is higher. In a way, this is consistent with the issues arising in the literature examining effects of debt overhang on growth.

Third, the state-dependent effects of the fiscal position on multipliers is attributable to two factors: an interest rate channel through which higher borrowing costs, due to investors’ increased perception of credit risks when stimulus is implemented from a weak initial fiscal position, crowd out private investment; and a Ricardian channel through which households reduce consumption in anticipation of future fiscal adjustments.”

What this means is that low interest rates (accommodative monetary policy) may be supporting positive effects of fiscal expansion, but at a cost of reducing private investment. In a sense, public investment, requiring lower interest rates, crowds out private investment. Now, no medals for guessing which environment we are witnessing today.

Some charts

First, median responses to increased Government spending

Once you control for debt/GDP position with stimulus taking place during recessions:

“Note: The graphs show the conditional fiscal multipliers during recessions for different levels of fiscal position at select horizons… Government debt as a percentage of GDP is the measure of fiscal position and the values shown on the x-axis correspond to the 5th to 95th percentiles from the sample. …Fiscal position is strong (weak) when government debt is low (high). Solid lines represent the median, and dotted bands are the 16-84 percent confidence bands.”

In the two charts above, notice that the range of public debt/GDP ratios for positive growth effect (multiplier > 1) of fiscal policy is effectively at or below 25%. At debt levels around 67%, fiscal expansion turns really costly (negative multipliers) in the long run. How many advanced economies have debt levels below 67%? How many below 25%? Care to count? Five  economies have debt levels below 25% (Estonia, Hong Kong, Macao, Luxembourg and San Marino). For 67% - nineteen out of 39 have debt levels above this threshold. Not exactly promising for fiscal expansions...

Overall, the paper is important in: (1) charting the relationship between fiscal policy effectiveness, and debt position of the sovereign; (2) linking coincident fiscal and monetary expansions to weaker private investment; and (3) showing that in the long run, fiscal expansion has serious costs in terms of growth and these costs are more pronounced for countries with higher debt levels. Now, about that idea that Greece, or the rest of PIGS, should run up public investment to combat growth crisis…

11/9/16: BRIC PMIs: Composite Activity - August

In the previous post I promised to update Composite PMI indicators for BRIC economies, so here it comes.

The good news is that Russia and India are posting Composite readings that are statistically significantly above 50.0 for the second month in a row. For Russia, this is the third consecutive month of Composite PMI readings statistically above 50.0 and for India - second.

The bad news is that Brazil acts as big drag on BRIC growth with severely depressed Composite PMI reading for 18th month running. Worse, Brazil's position has deteriorated in August compared to July.

Meanwhile, China posted virtually unchanged Composite PMI in August compared with July, with both readings being very close to signalling statistically significant expansion. Last time China posted statistically significant reading above 50 line was in August 2014.

Couple of charts to illustrate the trends:

As the chart above indicates, Russia remains a driver to the upside in terms of BRIC economies PMIs, with Brazil acting as a major drag and China as a driver toward lower growth.

Good news: across overall BRIC grouping, growth remains positive (albeit very shallow) and is ticking up (albeit with increased volatility). Bad news: since 1Q 2013, BRIC economies as a group are showing extremely low growth performance compared to their historical trends (red box in the chart below).

11/9/16: BRIC PMIs: Services & Manufacturing - August

With full 3Q 2016 update on PMIs coming up relatively soon, and having not done monthly updates on the time series for some time now, here is a quick summary of BRIC Manufacturing and Services PMIs through August 2016:

On Manufacturing side:

  • Brazil remains firmly stuck under 50.0 and the talk about improvements in the economy is highly premature. The rate of contraction did slow down a bit in recent months, but getting worse more slowly is not equivalent to getting better. With 19 consecutive months of sub-50 readings, the manufacturing side of Brazil's economy remains deeply sick. Last time Brazil's manufacturing posted statistically significant growth was in March 2013. Ouch!
  • Russia has been posting volatile manufacturing PMIs headlines for some time now. August reversion of PMI to 50.8 - statistically indistinguishable from 50.0 - offers no change to this pattern. That said, Russian Manufacturing appears to be stable, as opposed to contracting. Last 3mo average is at 50.6 - which, statistically, signals zero growth. This compares somewhat positively against 48.6 3mo average through May 2016. Overall, Russian manufacturing has not posted statistically significant growth reading - based on PMIs - since December 2014, with exception of one month (June 2016).
  • China's Manufacturing PMI posted a non-contractionary reading of 50.0 (zero growth) in August, down from 50.6 in July. In statistical terms, Chines manufacturing posted contraction or zero growth readings for 25 consecutive months now.
  • India continued to post significantly positive growth in manufacturing, based on PMIs. Over the last 8 months index reading stayed above 50.0 (statistically above 50.0 in 4 months out of 8). Current expansionary period in Indian manufacturing is now 8 months long and strengthening.
Chart below summarises trends in Manufacturing PMIs

The above shows that Manufacturing sectors are converging toward growth recovery in Russia and China, while India remains well-ahead of the rest of BRIC economies in terms of positive growth momentum. Brazil is on a clear downward trend and has decoupled from the other BRICs.

Services sectors:

As the above illustrates:

  • Brazil services sectors posted yet another month of declining growth, with rate of decline accelerating in August compared to July. This marks 18th consecutive month of negative growth in the services sector in the country. As with manufacturing, country services have been performing extremely poorly since March 2013, when structural (long-term trend) slowdown in growth kicked in.
  • Russia services sectors posted 7th consecutive month of above 50.0 readings, signalling relatively strong (albeit slower than in July) recovery. Over the last 6 months, Russia posted statistically significant growth in 5 months, which is rather solid sector recovery compared to the same period of 2015.
  • Chinese services sectors never posted a reading below 50.0 in the entire history of the time series. However, in August, the series reading of 52.1 was stronger the July reading and marked the third time the series were statistically above 50.0 over the last 6 months. This suggests some firming up in the services sector growth in China - a welcome relief to the rather pessimistic outlook projected by the PMIs in previous months.
  • India services PMI rose strongly to statistically significant reading of 54.7 in August, marking 14th straight month of above 50.0 readings (in level terms). August was the third month out of the last 6 months with statistically significant growth reading.

Just as with manufacturing, BRIC services sectors posted continuous improvements in trading conditions in India, China and Russia over the recent months. Brazil, however, remains significant drag on BRIC growth with no signs of convergence to the rest of the BRIC economies in sight.

Overall: both Manufacturing and Services PMIs suggest that BRIC economies as a group continue to act as a moderating factor on global growth trends. Although no longer dragging the global economy into growth recession, the block of largest emerging markets economies is not exactly propelling world growth to higher trend levels. However, more analysis on this later, with Composite indicators.

Wednesday, September 7, 2016

7/9/16: Don't Tell the Cheerleaders: U.S. Corporates Are Getting Sicker

Some at the U.S. Fed think the U.S. economy is in a rude health (, and others in the financial world think the U.S. corporates are doing just fine ( But the reality is different.

In fact, U.S. companies are bleeding cash like there is no tomorrow ( and they are doing so not to support capex or investment, but to support share prices.
Source: Bloomberg

And earnings are down:

Meanwhile, earnings per share are falling (and not only in the U.S.), as noted here:

And here is 12 ko Forward P/E ratio for the U.S. on 12mo MA basis:
iSource: FactSet

And it gets worse on a trailing basis

So, quite obviously, things are really going swimmingly in the U.S. economy... as long as you don't  look at the production / supply side of it and focus on 'real' indicators like jobs creation (unadjusted for productivity and quality) or student loans (unadjusted for risk of default) or home sales (pending or new, of course, but not existing). Which should be helped marvelously by a Fed hike, because in a credit-based economy, sucking out fuel vapours from an empty tank is undoubtedly a great prescription for sustaining forward growth.

Tuesday, September 6, 2016

6/9/16: The Pain in Spain: Growth vs Structural Deficits

FocusEconomics have published an interesting research note on Spanish economy. 

The country has been muddling through 

  1. An ongoing political crisis - with already two elections failing to produce a Government and the latest failed efforts at forming one last week suggesting there is a third round of voting ahead - and 
  2. The long-running fiscal crisis - with the EU Commission initiating series of warnings about Spain's failure to comply with the Fiscal Compact criteria and warning that the country is falling behind on deficit targets
Yet, despite these apparent macro risks, the economy of Spain has been expanding for some time now at the rates that are ahead of its other EURO 4 peers (Germany, France and Italy). 

In a guest post below, FocusEconomics shared their research with Trueeconomics readers:

The Pain in Spain: Robust GDP growth cannot mask the persistent structural deficit

Spain’s robust GDP growth despite the ongoing political impasse has made the headlines time and time again. The panel of 35 analysts we surveyed for this month’s Consensus Forecast expect GDP to expand 2.8% in 2016, one of the fastest rates in the Eurozone this year, before decelerating to 2.1% in 2017. 

And yet both Spain’s Independent Authority for Fiscal Responsibility (Airef) and the European Commission have warned in recent months that Spain is relying too heavily on GDP growth to reduce its deficit while neglecting much-needed progress with structural reforms to reduce its sizeable structural deficit (the part of the overall deficit which is adjusted for temporary measures and cyclical variations). This leaves it vulnerable to its deficit increasing in the future should economic conditions become unfavorable again. 

According to the Airef, without further reforms, a structural deficit of approximately 2.5% will still persist in Spain in 2018. 

Meanwhile, the European Commission predicted in its updated spring forecast that the structural deficit will reach 3.2% that year—well beyond the new 2.1% revised structural deficit target for 2018 (as part of an overall 2.2% deficit target) that it recently announced in July. Spain’s general government deficit is the sum of the deficits of the central government, the regional governments, the local authorities and the social security system, and most of the overshoot is expected to come from the underperformance of the regional governments and social security. Spain has gradually been reducing its overall general government deficit in recent years, albeit not at the speed stipulated by the European Commission, but it is the persistence of the structural part of the deficit that is the main cause for concern.

After deciding last month to waive the budgetary fine on Spain for missing its targets, the European Commission set a new series of targets up until 2018 in order finally to bring Spain’s overall deficit below the long-targeted 3% that year. In 2016 it expects Spain to meet an overall general government deficit target of 4.6%, not more than 3.1% of which is expected to be a structural deficit. This is in line with the European Commission’s updated spring forecast for the country, since it has decided not to impose additional adjustment requirements on Spain this year (attributing this in part to the fact that lower-than-expected inflation, which is out of the government’s control, has hindered deficit reduction efforts this year). In 2017 and 2018, however, the Spanish government will have to implement structural reforms to make savings equivalent to 0.5% of GDP each year to bring its structural deficit down to 2.6% in 2017 (as part of an overall deficit target of 3.1% that year) and 2.1% in 2018 (as part of an overall deficit target of 2.2%). Achieving this will require a strong government able to press ahead with a reform program—something which currently looks rather a panacea. Spain’s ongoing failure to form a new government since the first inconclusive elections in December last year may not have impacted the current resilience of its GDP growth, but it certainly puts its fiscal compliance in jeopardy and prolongs the structural problems of its economy.

The agenda ahead is tight. Under the Spanish Constitution, 1 October is the deadline for the government to present its proposed 2017 budget to the Spanish Parliament. And under the EU’s rules, the European Commission must receive the budget (which must, of course, indicate how Spain will meet the required 2017 targets) by 15 October, or Spain faces a fine. Spain is still struggling to form a government after two elections in the last nine months and looks highly unlikely to have a new government in place by October that is able to push through a budget with the requisite reforms. Mariano Rajoy, who heads the current caretaker Popular Party (PP) government and is seeking to be sworn in as prime minister again, failed to garner sufficient support at both his first investiture attempt on 31 August (for which he would have needed an absolute majority in his favor) and his second attempt on 2 September (at which a simple majority would have sufficed). He might have another attempt at being appointed after the regional elections in the Basque Country and Galicia at the end of September if by chance the circumstances look more favorable by then, but otherwise Spain will probably be going to the polls again on 25 December, in what would be an unprecedented event. Even if a new government is formed by some miracle, it looks highly likely to be a weak one that might not manage to last long, let alone implement a convincing reform program.

Click on the image to enlarge

A closer look at the political turmoil

Spanish parties are simply not used to formal coalition politics at central government level, and don’t seem to be willing to adapt to the times in a hurry. Since 1982, either one or other of the two main parties, the conservative PP and the Socialist Party (PSOE), had always managed to form either a majority government or alternatively a strong minority government, in the latter case achieving working majorities by striking mutually beneficial deals with regionally-based nationalist parties—especially in the Basque Country and Catalonia—to secure their support in the Spanish Parliament (a classic case of “I’ll scratch your back if you scratch mine”). Neither party was prepared for two quite successful newcomers—the populist left-wing Podemos (“We Can”) and the centre-right Citizens party (C’s)—coming along to break up their longstanding dominance, at the same time as the pro-independence wave in Catalonia makes reviving the traditional mutual support arrangements with the Catalan nationalist parties impossible. 

The re-run elections held on 26 June have so far simply resulted in another stalemate. The PP won again and this time managed to increase its seats from 123 to 137, but it still fell far short of an absolute majority of seats (176) in Spain’s Parliament. The only plausible option for Rajoy in the circumstances is to form a minority government, since both the PSOE and C’s ruled out the possibility Rajoy had initially advocated of a “grand coalition” comprising the PP, the PSOE and potentially C’s too—an option which market participants had considered the most likely to deliver the structural reforms Spain needs, but which would not have provided the “government of change” that so many Spanish citizens voting for new parties seek. Rajoy had managed to reach an agreement with C’s (32 seats) for it to support his investiture attempts on 31 August and 2 September, as well as the commitment of the one MP from the Canary Coalition (CC) to do the same, but he failed to secure the 11 abstentions he would also have needed to be voted in on the second attempt with a simple majority. This would have required some of the PP’s arch rival the PSOE to abstain, and PSOE leader Pedro Sánchez remains absolutely adamant that his party will continue to vote against Rajoy instead. Sánchez is in a weak position since the PSOE declined at the re-run elections and is under pressure from Unidos Podemos (an electoral coalition between Podemos, the United Left party and some other smaller left-wing forces), so he is not in a strong position to try and form a government himself, but he does not want to lose yet more voters to Unidos Podemos by being seen to allow or to prop up a conservative government either. It looks like only an internal crisis within the PSOE could possibly change the circumstances.

There is an outside chance that Rajoy could attempt an investiture vote again after the Basque regional elections on 25 September, if it looks like he might be more likely to get the Basque Nationalist Party (PNV)—which has 5 seats in the Spanish Parliament—on board then, to continue to boost his numbers and up the pressure on the PSOE to deliver the final few abstentions. The only plausible circumstance in which the PP might stand any chance of getting the PNV on side is if, after the Basque regional elections, the PNV itself finds it needs the PP’s support to be able to govern in the Basque region. This is not totally beyond the realm of possibility, since the PNV is likely to win the Basque elections with a minority of votes and could struggle to form a working majority, especially if its traditional ally, the Basque Socialist party (PSE)—the Basque federation of the PSOE—declines as expected amid the rise of Podemos, which could potentially build alliances with other left-wing forces including the Basque anticapitalist and secessionist EH Bildu coalition of parties. Podemos is proving particularly attractive in the Basque Country (and Catalonia too) given that it is the first Spanish party to support the idea of self-determination for Spain’s constituent territories. Indeed, the PNV itself, a traditionally centre-right party which is struggling to attract the younger generations of Basque voters, is far from immune to the risk of losing some of its voters to the populist party: at the Spanish general election re-run in June, it was significant that Unidos Podemos beat the PNV not only in terms of votes but also seats in the PNV’s traditional Basque stronghold of the province of Vizcaya (one of the three provinces making up the Basque region). In these changing circumstances, the PNV could possibly end up needing the support of the PP in the Basque Parliament in order to govern, which would inevitably require it to return the favour in the Spanish Parliament, but this is only one of various possible outcomes at this stage and the PNV certainly looks highly unlikely to contemplate this option as anything but a very last resort.  

Summing up

Overall, the political impasse thus looks set to continue for the foreseeable future—though if we’re looking for silver linings, at least Spain’s nearly nine-month hiatus is still nowhere near Belgium’s 2011 record of 19 months without a government. Spain faces unprecedented challenges as it undergoes a fundamental political transformation stemming from the widespread disillusionment with existing political institutions and actors and the emergence of new players, not to mention the territorial crisis due to the Catalan challenge to the integrity of the Spanish state. While Spain’s GDP growth has remained remarkably resilient in recent quarters, there is no room for complacency. The country’s persistent structural deficit—which cannot be effectively addressed during the current political deadlock—still renders its economy particularly vulnerable to future changes in economic climate and puts the country on a collision path with Brussels over the required fiscal consolidation trajectory. 

Author: Caroline Gray, Senior Economics Editor, FocusEconomics

Monday, September 5, 2016

4/9/16: Earnings per Share

You know the meme: corporate sector is healthy world over and the only reason there is no investment anywhere in sight on foot of the wonderfully robust earnings is that… err… political uncertainty around the U.S. elections. Because, of course, political uncertainty is everything…

Except when you look at EPS

H/T @zerohedge 

Now, what the above is showing?
1) EPS is down in the politically ‘uncertain’ U.S.
2) EPS is even more down in the politically less ‘uncertain’ Europe (though you can read on that subject here:
3) EPS has been falling off the cliff since the ‘political uncertainty’ (apparently) set in 4Q 2012 in the U.S. One guess is the markets expected, correctly, the epic battle between The Joker and the Corporate Godzilla back then. And in Europe, since mid 2013, apparently, markets had foresight of who knows what back then.

But never mind, there is no secular stagnation anywhere, because earnings are, apparently very very healthy… very robust… very encouraging… All of which means just one thing: the markets are not overpriced or overbought. Pass de Kool-Aid, lads!

Sunday, September 4, 2016

4/9/16: Some Points on Russian & European Policy Uncertainty Trends

With some positive (albeit very weak still) changes in the Russian macroeconomic news in recent months, it is worth looking at the evolution of trends in Russian policy uncertainty, as measured by the data.

Here is an updated (through August 2016) chart comparing news-based indices of policy uncertainty in Russia and the EU

Note, series above are rebased to the same starting point for the EU and Russia (to 1994 annual average) to make them compatible.

Things of note:

  • Russian policy uncertainty continues to trend below that of the EU
  • The above conclusion is also confirmed in raw data 3mo averages and 3mo exponential moving averages
  • This is nothing new, as general policy uncertainty has been systemically lower in Russia than in Europe since the peak of the Russian Default crisis of the late 1990s, with exception for two episodes: brief period in 2006-2007 - the starting point of Russian-Georgian trade and migration pressures; and 2014-2015 period - marked by first economic slowdown in the early 2014, followed by the Russian-Ukrainian conflict and the Ruble crisis
  • Generally, the EU continues to show growing trend divergence with Russia when it comes to policy uncertainty, despite the more moderation in the underlying series since the end of the latest spike caused by the Greek crisis earlier this year (IMF participation and Tranche 2 disbursement)
It is worth noting that, despite a rise in the U.S. uncertainty index due to the ongoing election cycle, the U.S. comparatives are similar to those of Russia, as opposed to the EU. 

Saturday, September 3, 2016

3/9/16: Fintech, Banking and Dinosaurs with Wings

Here is an interesting study from McKinsey on fintech role in facilitating banking sector adjustments to technological evolution and changes in consumer demand for banking services:

The key here is that fintech is viewed by McKinsey as a core driver for changes in risk management. And the banks responses to fintech challenge are telling. Per McKinsey: “More recently, banks have begun to capture efficiency gains in the SME and commercial-banking segments by digitizing key steps of credit processes, such as the automation of credit decision engines.”

The potential for rewards from innovation  is substantial: “The automation of credit processes and the digitization of the key steps in the credit value chain can yield cost savings of up to 50 percent. The benefits of digitizing credit risk go well beyond even these improvements. Digitization can also protect bank revenue, potentially reducing leakage by 5 to 10 percent.”

McKinsey reference one example of improved efficiencies: “…by putting in place real-time credit decision making in the front line, banks reduce the risk of losing creditworthy clients to competitors as a result of slow approval processes.”

Blockchain technology offers several pathways to delivering significant gains for banks in the area of risk management:

  • It is real-time transactions tracking mechanism which can be integrated into live systems of data analytics to reduce lags and costs in risk management;
  • It is also the most secure form of data transmission to-date;
  • It offers greater ability to automate individual loans portfolios on the basis of each client (irrespective of the client size); and 
  • It provides potentially seamless integration of various sub-segments of lending portfolios, including loans originated in unsecured peer-to-peer lending venues and loans originated by the banks.

Note the impact matrix above.

Blockchain solutions, such as for example AID:Tech platform for payments facilitation, can offer tangible benefits across all three pillars of digital credit risk management process for a bank:

  • Meeting customer demand for real-time decisions? Check. Self-service demand? Check. Integration with third parties’ platforms? Check. Dynamic risk-adjusted pricing and limits? Check
  • Reduced cost of risk mitigation? Yes, especially in line with real-time analytics engines and monitoring efficiency
  • Reduced operational costs? The entire reason for blockchain is lower transactions costs

What the above matrix is missing is the bullet point of radical innovation, such as, for example, offering not just better solutions, but cardinally new solutions. Example of this: predictive or forecast-based financing (see my earlier post on this

A recent McKinsey report ( attempted to map the same path for insurance industry, but utterly failed in respect of seeing the insurance model evolution forward beyond traditional insurance structuring (again, for example, FBF is not even mentioned in the report, nor does the report devote any attention to the blockchain capacity to facilitate predictive analytics-based insurance models). Tellingly, the same points are again missed in this month’s McKinsey report on digital innovation in insurance sector:

This might be due to the fact that McKinsey database is skewed to just 350 larger (by now legacy) blockchain platforms with little anchoring to current and future innovators in the space. In a world where technology evolves with the speed of blockchain disruption, one can’t be faulted for falling behind the curve by simply referencing already established offers.

Which brings us to the point of what really should we expect from fintech innovation taken beyond d simply tinkering on the margins of big legacy providers?

As those of you who follow my work know, I recently wrote about fintech disruption in the banking sector for the International Banker (see The role of fintech in providing back-office solutions in banking services is something that is undoubtedly worth exploring. However, it is also a dimension of innovation where banks are well-positioned to accept and absorb change. The real challenge lies within the areas of core financial services competition presented (for now only marginally) by the fintech. Once, however, the marginal innovation gains speed and breadth, traditional banking models will be severely stretched and the opening for fintech challengers in the sector will expand dramatically. The reason for this is simple: you can’t successfully transform a centuries-old business model to accommodate revolutionary change. You might bolt onto it few blows and whistles of new processes and new solutions. But that is hardly a herald of innovation.

At some point in evolution, dinosaurs with wings die out, and birds fly.

3/9/16: Innovation policies scorecards: Euro Area and BRIC

An interesting, albeit rather arbitrary (in terms of methodology) assessment matrix for innovation environment rankings across a range of countries, via EU Commission.

Here are the BRIC economies:

All clustered in the “Above Average Harmful Policies” (negative institutional factors) and “Below Average / Average Beneficial Policies” (positive institutional factors). Surprisingly, however, India sports the worst innovation policies environment, followed by China (where “Beneficial Policies” are, of course, skewed by state supports for key sectors). Russia comes in third (where the beneficial policies are most likely skewed to the upside by so-called strategic sectors, also with heavy state involvement). You might laugh, because with Brazil being fourth 'least detrimental' environment for innovation, the EU rankings are clearly at odds with actual innovation outcomes ( where
  • China = rank 29
  • Russia = rank 48
  • Brazil = rank 70
  • India = rank 81

Looking at the contrasting case of key advanced economies with strong supports, one wonders how much of Ireland’s policy environment is due to multinationals’ accommodation and just how on earth can such an ‘innovation-centric’ economy be so ‘average’ in terms of its innovation policies despite hundreds of millions pumped into supporting indigenous innovation. 

Then again, look at Finland with its stellar innovation policies culture and… err… economy in total coma

Makes you think… 

2/9/16: Does bank competition reduce cost of credit?

In the wake of the Global Financial Crisis, there has been quite a debate about the virtues and the peril of competitive pressures in the banking sector. In a paper, published few years back in the Comparative Economic Studies (Vol. 56, Issue 2, pp. 295-312, 2014, myself, Charles Larkin and Brian Lucey have touched upon some of the aspects of this debate.

There are, broadly-speaking two schools of thought on this subject:

  1. The market power hypothesis - implying a negative relationship between bank competition and the cost of credit (as greater competition reduces the market power of banks and induces more competitive pricing of loans). This argument is advanced by those who believe that harmful levels of competition can lead to banks mispricing risk while competing with each other. 
  2. The information hypothesis postulates a positive link between credit cost and competition, as the banks may be facing an incentive to invest in soft information. 

Now, a recent paper from the Bank of Finland, titled “Does bank competition reduce cost of credit? Cross-country evidence from Europe” (authored by Zuzana Fungáčová, Anastasiya Shamshur and Laurent Weill, BOFIT Discussion Papers 6/2016, 30.3.2016) looks at the subject in depth.

Per authors, “despite the extensive debate on the effects of bank competition, only a handful of single-country studies deal with the impact of bank competition on the cost of credit. We contribute to the literature by investigating the impact of bank competition on the cost of credit in a cross-country setting.” The authors take a panel of companies across 20 European countries “covering the period 2001–2011” and study “a broad set of measures of bank competition, including two structural measures (Herfindahl-Hirschman index and CR5), and two non-structural indicators (Lerner index and H-statistic).”

The findings are interesting:

  • “bank competition increases the cost of credit and …the positive influence of bank competition is stronger for smaller companies”
  • These results confirm “the information hypothesis, whereby a lack of competition incentivizes banks to invest in soft information and conversely increased competition raises the cost of credit.” 
  • “The positive impact of bank competition is influenced by two additional characteristics. It is lower during periods of crisis, and the institutional and economic framework influences the relation between competition and the cost of credit.”
  • Overall, however, the “positive impact of bank competition is …influenced by the institutional and economic framework, as well as by the crisis.”

The authors ‘take-away lesson” for policymakers is that “pro-competitive policies in the banking industry can have detrimental effects, … [and] banking competition can have a detrimental influence on financial stability and bank efficiency.”

I disagree. Judging by the above, higher costs of credit overall, and higher costs of credit for smaller firms, may be exactly what is needed to induce greater efficiency and reduce harmful distortions from over-lending. As long as these higher costs reflect actual risk levels.

Friday, September 2, 2016

2/9/16: Forecast-based Financing and Blockchain Solutions

As the readers of this blog know, AID:Tech ( is a new venture I am involved with that uses blockchain platform for provision of key payments facilitation services for people in need of emergency and continued assistance (refugees, international aid recipients, disaster relief aid and general social supports payments). As a part of the market analysis and strategy, we have encountered an interesting, rapidly evolving services segment relating to disaster relief: the concept of Forecast-based Financing (FBF) worth highlighting here.

Under FBF, aid providers release humanitarian aid-related funding ahead of the adverse event taking place, based on forecast information that aids in predicting the severity, timing and impact distribution of the disaster (natural or man-made). This approach to aid delivery aims to:

  • Reduce key risks (e.g. assuring that delivery is timed in line with the adverse shock, focused on key geographic and demographic audiences, uses pre-disaster - and thus more efficient - supply chain networks, etc), 
  • Enhance preparedness and response (by increasing quality of aid targeting and allowing to concentrate resources in the areas where they are needed most and ahead of the actual disaster impact), and 
  • Make disaster risk management overall more effective by assuring that aid resources are present at the time of the disaster and after the disaster impact, thus reducing losses and delays in delivery of aid that may arise as the result of the disaster (e.g. destruction of roads and disruptions in power supplies, etc).

In general, FBF framework is open to several questions and objections, all requiring addressing.

How does FBF work? 

A humanitarian aid agency and stakeholders (e.g. meteorological services and communities at risk) jointly create a contingency plan, outlining key actions to be taken ahead of the probabilistically likely disaster or shock. They also set out specific metrics that define the trigger for aid pre-delivery, based on a model risk forecast reaching a specific threshold of probability. Linked to severity of forecast shock, specific budgets are set aside for activation. Once the risk probability threshold is breached, aid is delivered to the location of possible disaster, using pre-disaster supply chain management structures before these get disrupted by the event.

Forecast errors: are these really costly?

Probabilistic forecasts are never 100% accurate, which means that in some instances, aid will be delivered to the communities where the adverse event (a shock) might end up not materialising, despite probability models generating high likelihood of such an event. In a way, this is the risk of aid agencies providing disaster relief “in vain” or “wasting” scarce resources. It is worth noting that probabilistic errors of “wastage” can be significantly over-estimated, as some disasters can be relatively well forecast in advance ( Quality of forecasting will, of course, co-determine losses in the system.

To achieve system-wide efficiency and secure gains from implementing an FBF programme, one has to be able to counter-balance the benefits of early response,including those arising from more efficiency in accessing supply chains pre-disaster and reducing the cost of disaster, against the likelihood of a loss due to probabilistic basis for the action. This can be done via two channels:

  1. Assuring that during planning, the cost of acting pre-emptively, including the cost of probabilistic ‘waste’, is factored into planning for which forms of aid should be pre-delivered and on what scale; and
  2. Assuring that aid supply chain and forecasting models are optimised to delver highest efficiencies possible.

Over time, development of FBF will also require changes in supply chain management to mitigate losses due to “wastage”. For example, putting more emphasis on local (or proximate) sources for supply of critical aid can reduce “wastage” by lowering cost of deliveries and by closely anchoring pre-disaster deliveries to existent markets for goods and services (so at least some pre-delivered aid can be returned into local markets in the case if probabilistically likely disaster does not materialise).

In other words, aid agencies and potentially impacted communities need to have access to timely and accurate information on which resources are needed in responding to a specific disaster, on what scale and, crucially, which resources are already available in the supply chain and in the local or proximate markets. The key element to this is ability to track in real time supply chains of goods and services accessible at differential cost to specific communities in cases of specific disaster events. The agreed (in advance) standard operating procedures (SOPs) that are set between the aid providers and the recipient communities must be both realistic (reflective of measures necessary in the case of specific disaster) and effective (reflective of the balance of cost-benefit).

Put differently, the process of FBF is the process of, first and foremost, planning and data relating to supply chain management.

Are there any tangible experiences with FBF?

One early example of FBF implementation is the case of the Red Cross Red Crescent Movement that has field-tested an FBF programme Uganda and Togo. This project bridged financial and technical support from the German government and Red Cross, and used technical support from the Climate Centre.

Another case is of FoodSECuRE initiative by the World Food Programme that is currently in planning stages. In this programme, private sector partners (aviation services providers, insurance companies etc) are engaged in FBF planning for alleviation of potential flooding due to El Niño effects in Peru ( and Both of these experiences show also the importance of setting aside sufficient response funds for FBF delivery.

Further afield, FBF pilots are being run or planned by the WFP and other organisations in Bangladesh, the Dominican Republic, Haiti, Mozambique, Nepal and the Philippines.

Note: the above cases were provided by the UNFDP research.

Overall, FBF is becoming one of the cornerstones of the global disaster aid delivery programmes and was endorsed by UN OCHA and the IFRC. FBF was also included in the International Federation’s special report ahead of the World Humanitarian Summit in Istanbul. The report included a pledge to facilitate a doubling of FbF within the Movement by 2018.

However, despite the aid agencies enthusiasm, the key problem relating to FBF remains largely unaddressed: currently, with some 20 percent of disaster aid being lost due to insufficient supply chain management, fraud and theft, delivering properly structured FBF requires exponentially greater exposure to data collection and analysis, as well as to strengthening of real-time supply chain visibility systems.

As AID:Tech example shows, these objectives can be supported via private and semi-private blockchain solutions.

2/9/16: Investment in Italy: Banks, Capital and Firms Structures

In my course on the enterprise and financial risk last semester, we talked about the peculiar (or idiosyncratic) nature of Italian firms across a number of matters:

  • Relationship banking;
  • Firm governance: family ownership, equity distribution and aspects of firm strategy and operations;
  • Firm capital structure (leverage risks in particular);
  • Firm dividend policy choices, etc.

Now, let’s add to that literature something new. A recent paper from the Banca d’Italia, titled “Investment and investment financing in Italy: some evidence at the macro level” by Claire Giordano, Marco Marinucci and Andrea Silvestrini (Banca d’Italia Occasional paper Number 307 – February 2016) looks at the evolution of the Global Financial Crisis and the Great Recession across the Italian economy in terms of credit fundamentals.

As noted by the authors, “following the outbreak of the global financial crisis, the euro area experienced a large fall in gross fixed capital formation, both in 2008-09 and during the sovereign debt crisis. This drop was dramatic in the countries more exposed to tensions in government bond markets. In Italy, in particular, total real investment has suffered a loss of around 30 per cent since 2007, the pre-crisis peak, reverting to its lowest levels since the mid-1990s. Weak investment also remained a key drag on GDP growth in 2014, although more recent quarterly data on capital accumulation point to a slight increase over the first three quarters of 2015 relative to the corresponding period in 2014.”

In a typical European fashion, investment in Italy must equal debt. In part, as I usually cover in my courses on risk and corporate financial strategies, this is tied to the reluctance of the family-owned firms to release equity. And in part, it is a part of a broader European debt disease. Independent of the reasons, per authors, the worthy corner to check for key investment-crises interlinkages is the credit supply.

“The depressed growth of investment is in contrast with the substantially muted aggregate financing costs, which stem from the low interest rate environment resulting from the strongly expansionary stance of monetary policy in the euro area. In this context, one scenario is that investment demand will remain too low to absorb financial savings, inducing a persistent state of an excess supply of funds in capital markets.” In other words, Italians are discovering secular stagnation: interest rates are too low because investment is too low (and may be, also the other way around).

With that in mind, the authors proceed to show that “medium-term gross fixed capital formation trends in Italy may be summarised along the following lines”:

Pre–2007 capital expansion “was broad-based, both across institutional sectors and asset categories, although less marked for households”, and Post-2007 “exceptional downturn …affected all sectors and components, yet to a different extent. In particular, focusing on the most recent period, the decline in general government and non-financial corporations’ expenditure, cumulatively undertaking about two thirds of total investment in Italy, was sizeable (approximately 25 per cent), yet slightly more contained than the concurrent drop in household investment spending.”

Overall, “the total-economy investment rate in Italy currently stands at its lowest levels since data became available in the mid-1990s; current government and non-financial corporation investment rates are comparable only to those recorded in 1995; the household rate is even lower. From the asset side, in recent years construction investment, in both residential dwellings and non-residential buildings, which represents half of total expenditure, was the hardest-hit item, excluding transport equipment expenditure (small and volatile), whereas ICT investment and the accumulation of intangible assets weathered the recent double-dip recession better.”

But the age of lower interest rates is having another impact on Italian credit markets. This impact is aggressive rolling over of maturing loans amidst deteriorating credit quality of borrowers. As the result, two things can be documented in Italian credit market experience since 2008 bust:

Firstly, overall, the trend toward longer debt maturity is present in household, corporate and government debt sectors (charts below). Secondly, this is doing nothing to repair credit quality on banks balance sheets.

Which is rocking, for now, as low interest rates are keeping debt burden down and allowing leverage to rise. But the problem is that with longer maturity of debt, we are looking at higher long term susceptibility to debt servicing costs. Last time that happened, Italy became on of the PIIGS. Next time it will happen… oh, ok… we shall just wait and hope Mario Draghi says true to his Italian roots long enough for the miracle to happen.