Tuesday, 26 October 2010

The Frankfurt dilemna - Ireland, hold on to your hat

So you think Ireland has some significant economic difficulties? Trying to manage our way off an explosive debt and deficit path for both the public sector specifically and the entire country generally is a painful adjustment.

Well, don't look now because things might get worse in the not too distant future. The reason is because short term interest rates might be on the way up before too long if recent trends continue, which if it comes to pass will make our adjustment even more painful and more difficult because the interest charge on the country's massive debt stock will rise too. Note that most of Ireland's total debt is subject to a variable, or short-term interest rate largely due to the concentration in variable rate mortgages of some description or another.

But why would interest rates increase? Surely it doesn't make sense. Well, tell that to those humourless suits at the Bundesbank who watch monetary aggregates like hawks. Those influential central bankers know that money supply figures have passed a clear turning point that means we should be ready to tighten monetary policy from its current sluice gates open mode.

Exhibit #1 - Monetary aggregates

M1 is narrow money, mostly notes and coins in circulation. M3 represents wider demand and interest bearing deposits in banks. Note what has happened to both in recent years. Before the full onset of the Global Financial Crisis (GFC) M3 was rising at a generous pace. People were borrowing from banks, that borrowing circulated back via economic transactions into deposits in banks. The Lehman Bros happened, at the point indicated in the chart. Initially it led to people putting wealth into cash (so M1 increased with an immediate spike) and then the ECB began cutting interest rates, promoting further growth in narrow money. M3 virtually stalled, as people didn't want to leave wealth on deposit with banks and the borrowing and deposit (known as money creation) cycle collapsed.

So this state of affairs continued. Until earlier this year. While M1 is still rising as monetary policy remains lax and interest rates remain low, M3 has started rising. The money creation process appears to have been rekindled. That is good news, because a continued downward money supply (M3) spiral would be a harbinger of deflation. However, it is also ominous in the sense that it indicates that the type of emergency low interest rates and lax monetary policy (including generous ECB repo lending and open market operations - e.g. Irish government bond purchase) may not be deemed appropriate any longer. That means higher ECB reference rates (the Refi. rate), which in turn will push up interbank rates and hence lead to higher retail rates, especially (say it softly) tracker and variable mortgage interest rates in Ireland.

Exhibit #2 - Euro monetary aggregates recent rates of growth

This chart shows the most recent rates of growth, annualised rolling quarterly growth rates. M3 is now growing for the first time in over a year and not much below 5%, which would be within a range considered to be consistent with the long term inflation target of the ECB - 2%.

Exhibit #3 - Euro monetary aggregates annual growth rates

Even the annual (year on year) rate of change of M3 has turn positive, while M1 is growing at rates that would only be acceptable for short periods of time.

Ireland had better watch out, because nobody seems to be talking about this big smelly elephant at the moment.

Thursday, 21 October 2010

Ireland versus Greece - the fiscal comparison

Budget silly season is now in full swing in Ireland. There are two gigantic myths that appear to be circulating generally, fed to the media who chew and the regurgitate without so much as thinking. The two I had in mind are:
  1. The much trumpetted and imminent 4 year fiscal plan is the initiative of the current coalition government to somehow rescue the economy, and

  2. Ireland has been and will continue to lead the way on fiscal austerity programs, in particular putting Greece in the shade.
Both are pure unadulterated fiction.

Yesterday there was a pow wow between the most important political parties in the Dail (plus the Green Party) to discuss an advance copy of a much trumpetted 4 year plan. The claim made by the government of the day is that this is of national importance and that some form of cross party consensus is needed on its content. I won't comment on that (it is complete political bollocks), but just note that the requirement for this medium term fiscal plan is enshrined in the Maastricht Treaty under Stability and Growth Pact. Ireland, like Greece needs to submit for approval by the European Commission a "Stability Program" that explains how the general government deficit will be trimmed to less than 3% of GDP by 2014.

Point 1. This is a legal requirement, not some admirable piece of national governance.

Next to how we mighty Irish are showing up those lazy Greeks. The general government deficit in 2009 was estimated at 11.7% of GDP (output), or in my preferred numeraire for Ireland 14.2% of GNP (income) - it makes a difference, doesn't it. For Greece the number was 13.8% of GDP and essentially the same as a proportion of GNP.

The first myth running around Ireland and sold to the rest of the world (as only the Irish can) was that Ireland had already introduced the most massive fiscal adjustments, while the Greek government had been sitting on its lazy bum.

Exhibit 1. - Comparable primary deficits

Source: European Commission, Greek Ministry of Finance

The primary deficit excludes debt interest, so it is a measure of budget items under the direct control of government. Well, knock me down with a smoked kipper. It looks like those lazy, profligate Greeks have been significantly more masochistic than our own bunch assorted teachers and country solicitors.

Hopefully more people will note this and not wonder why the streets of Athens were turned into a type of European Beirut, while the Irish electorate were characterised by the local media as being "docile in the face of much more draconian fiscal measure". Let's agree right here and right now that this type of statement was and still is a bare faced lie. Regardless of the economic merits of such a fiscal contraction being implemented by Greece, there is no case that Ireland was making more significant budget adjustments. I know that a new raft of expenditure cuts and tax increases are about to be announced in Ireland, but even €5 billion in measures will amount to about 4% of GNP would only, at best, represent catch up with the measures already being implemented in Greece.

Of course these are primary deficits and they do not include interest on the stock of government debt. In the case of Greece , such interest costs amount to more than 7% of GNP and mean that they won't have completed the necessary fiscal adjustment until the primary balance is in significant surplus (that 7% of GNP deficit including debt interest would keep Greece on debt death spiral). However, that is irrelevant to the point being addressed here. The Greek government has been far more courageous (or stupid, depending on your point of view) than the Irish government to date.

Monday, 18 October 2010

Damien Kiberd ... aaaahhhhh!!!!!

Another Sunday, another self inflicted hair loss. To be honest, it is my own stupid fault. Why can't I resist passing over Damien Kiberd's weekly rantings of ignorance in the Sunday Times.

How this man, who by all appearances is just some chancing journo, equally qualified to be writing about this season's womens' Autumn fashions as economics or finance continues to get access to national media is the comic indictment of ongoing economic failings of Ireland. Idiots in charge at all levels.

In his latest rantings Kiberd keeps beating his drum about "confidence" and "consumer spending". He goes so far to advocate an extension of the car scrappage scheme because it would "increase tax revenues". Words fail me how stupid and dangerous this man is with regard to issues concerning the economy and our future welfare.

Ireland as an entity - that means Irish people in aggregate - has consumed far far far too much. We have consumed everything we have and everything we will manage to earn over the next couple of decades. This goes for the government who has done the same on our (taxpayers) behalf. Kiberd is saying that we should build an even larger stock of personal debt and/or spend savings in order to hand money over to a government who needs to cut spending.

I imagine Kiberd would probably retort something along the lines of "well, at least everyone will have a nice shiny car in the driveway". Yeah, brilliant Damien. We can park them in one of the numerous shiny new housing estates that lie empty around the country. Don't think for a moment Damo that we forget your enthusiasm for the property boom, right up to the point the bubble imploded. Why, I believe you are in print claiming Ireland would be suffering a severe housing supply shortage in 2008. Unbelievable.

This man is worse than a fool (someone who speaks beyond their capacity), his media prominence on both radio and print make him a dangerous one.

Sunday, 17 October 2010

"Capitalism" to the rescue

I really shake my head at the persistence of failed Socialist views of the world. The supposed values that leftist thinking is supposed to bring is almost universally trumped by market-based solutions, which come from allowing personal and economic freedoms combined with just the right amount of regulation and law where it is needed (and no more)

One of the last places you would look for evidence of the massive benefits of this wonderful system might be the recent Chilean mining rescue. Have a read, it is revealing stuff.

Thursday, 14 October 2010

So you want to become an internet squillionaire...

The first thing to do is to learn some economics. Alternatively you might be naturally endowed with all the right sort of intuitive skills to help you make the correct commercial decisions.

Have a look at this review of the new Facebook movie that documents (to greater or lesser historical accuracy) Mark Zuckerberg's development of the ubiquitous social networking site. How did this not only become so successful, but also something of such commercial value? Here is a clue in the movie, if it is indeed true:

He resisted bombarding users with advertising, believing it best to let the service reach its natural market size without offending them. This is accurately portrayed in the movie; his early business partner Eduardo Saverin insists the company has to immediately "monetize" and Zuckerberg refuses. He still believes that growth is more important than short-term monetization.

A nice exposition of two important concepts; "switching costs" and "network externalities". Take the second first. The phrase network externalities refers to positive indirect effects that accrue to third parties. Elsewhere I have blogged on the more talked about negative externalities, but here is a case of positive ones.

A Facebook with two users provides very little "utility" or value for either of its users. If two more people join then instantly the value to the existing users increases. Why? Because of the additional connections, contributions etc. that those additional people bring. Let's say that the users find the larger Facebook network with twice as many contributors twice as interesting/useful/fun and that feeling is shared by the other users. The size of the network has doubled (from 2 to 4 users) but the value of the network has increased from 2 x 1 = 2 to 4 x 2 = 8; a multiple of 4!! That is network externalities at work; a network gains its value from the number of connections.

Zuckerberg was perfectly correct to resist those urging an early commercialisation of his network, realising (supposedly) that its value would grow exponentially relative to its size. The return to being patient was potentially - and subsequently proven to be - enormous.

What about the other concept - "switching costs". Not only did Zuckerberg appear to realise the need to wait and let the implications of network externalities run their profitable course, but he was reputed to have been concerned about "offending his users". Again, wise to the economics of his website. What is implicitly recognised here is that regardless of how much value the users of Facebook (customers) personally derived from being a member of the network, the only amount that he as owner of Facebook could extract from these same users was the cost any user would bear from leaving - that is each user's "switching costs". And when Facebook was smaller, before the Network externalities had really kicked in and there were other similarly sized and even larger networks around, the switching costs of Facebook users was probably very small. Any actual or perceived cost imposed on Facebook users at that time - for example a user fee or even annoying advertising, could have led to mass desertion of Facebook users to one of the other popular networking sites of the time. Imagine how easy it is to jump ship from a Facebook with 10,000 members, compared to jumping from one with 500,000,000 members. For one thing, there is no alternative...

But Zuckerberg held his nerve and allowed Facebook to grow to the point that it was big enough that:
  1. The exponential growth via network externalities made Facebook very valuable to it users and
  2. That same size and associated network effect increased the switching costs of users to something meaningful; users would now be willing to tolerate some advertising or funnel some money into their use of Facebook.
These are two simple concepts that have been exploit knowlingly or otherwise by Internet winners (Microsoft, Google, Facebook etc.) and not understood by a myriad of losers.

Just a final note. Again something that the astute reader should have picked up. These two concepts together mean that network type industries or businesses will tend to be "winner take all", or natural monopolies. It is no accident that technological, informational or network industries are more commonly dominated by a small number of large participants compared with production or cost driven industries like manufacturing.

For the astute and most likely wealthy readers, there is a lesson for investing here also. Don't try and pick winners in this space. Simply try and cover the field so that you will have some money on the eventual winner.

Wednesday, 13 October 2010

"Equality"? Give me a break

The World Economic Forum is probably the most absurd "economic" organisations in the world. Famed for its ludicrous "competitiveness reports", it also produces other useless and complete harebrained "reports, like the "gender gap index".

The complete absurdity and nonsense of this type of work is apparent in its own methodology.

For example, Ireland demonstrates comparable "inequality" because men have a life expectancy of only 96% of that of women. The longer women live relative to men the more "equal society is apparently. So imagine if we could produce some "gender equality" policies that shifted this 96% figure to 90% or even 50% - hey that would probably generate a boost to the aggregate "equality" ranking.

The same absurdity appears in all the other comparable scores the boost the supposed "gender" equality as women increasingly dominate outcomes for men in education, representation in professional classes etc.

Next look at the male/female birth ratio. As pure statistical indicator, a low female to male birth ratio is in fact a boon to women - as China is now finding out. Women have complete control of the partner selection process. Men are increasingly left into the middle ages at the fringes of society. Perversely, this supposed "inequality" towards women is in fact leaving men not women disadvantaged in Chinese society.

I don't think I will bother with this report.

Tuesday, 12 October 2010

Tricks of the trade

One of my favourite, non-moralist based, parables against protectionism or mecantilism comes via Brad de Long (I can no, longer find the link).

In a fictional country that exported grain and imported cars, a protectionist movement developed that demanded imports of cars stop in favour of domestically produced cars.

As this movement built political momentum (”protect the jobs”, "buy local") a billionaire announced that he had discovered a technology that would allow for the transformation of grain, of which the country produced plenty, into cars, which the country at present imported. On the back of a substantial government grant (!), the billionaire built a sprawling site on the coast, protected by massive security. He employed a workforce that was sworn to secrecy and then began buying up large amounts of the locally produced grain.

The grain was shipped into the secretive site in trainloads and amazingly cars were shipped out to be sold to customers. The billionaire was a national hero, lauded by politicians for single handedly ending the need to import cars. No longer were imports needed. In addition, he was also a big buyer from domestic farmers (buying "local"). And of course he employed people and made huge profits which provided corporate tax revenues.

The country was universally in awe of this national miracle of economics, except for one curious journalist who managed to infiltrate the secretive site, into which the grain went and cars emerged.

This journalist discovered that the site, hidden from outside eyes, consisted of little more than a massive rail freight and dock facility. The grain was being transferred from the incoming trains on to bulk transports sailing off to foreign countries. At a different point, car transports were arriving, unloading their cargo onto trains heading off to be sold across the country.

Friday, 8 October 2010

Green investor update

With the end of the third quarter it is time to get an update on our green investments courtesy of HSBC.

It looks like another bad quarter, underperforming the broad equity market index by about 0.5%. On the bright side, performance is consistent. Consistently under performing the equity market, as I predicted but certainly not what HSBC or our friendly reporter at the Financial Times, Kate MacKenzie, predicted.

Since 2008 an investor in this HSBC green fund would have lost more than 20% against a standard global equity benchmark. Ouch. That is what I call suffering for your principles.

But then, maybe it isn't all about principles. Maybe some people do buy into the "green is the future" malarkey. There is an apt investment lesson in that case. Don't let your emotions bias your use of and interpretation of data. In this case, the data and facts pointed to subsidy reliant "green" industries and companies being poorly positioned to improve their profitability or grow their businesses. The clear message was sell.