Credit Rating Agencies – how countries stack up.

Here is a list of the latest ratings by the three main rating agencies. Notice that Australia and the three Scandinavian countries have top ratings. The UK lost its top rating from Moody’s but maintained the top rating from the other two. New Zealand comes in further down with a top rating from Moody’s but has lost its top grade from the other two. When you get to B status your are talking high risk or junk status and this is quite evident with the PIGS counties.

If you have watched the movie documnetary ‘Inside Job’ you will remember that these 3 credit rating agencies also rated high risk investments – sub-prime mortgages – as AAA, up to a week before they failed. The same could be said about their rating of investment company Bear Stearns.

Ultimately they could have ‘stopped the party’ but delayed ratings reports and made junk status investments AAA rated. But as they testified in front of congress their advice to clients are opinions ‘just opinions’ – I wonder do they share the opinions of those that lost huge amounts of money, including sovereign investments. Recently they downgraded Greece and Spain in the knowledge that the servicing of the debt would now become more costly for those countries and stifle any sort of recovery in the near future.

Paddy’s A to Z of the Economic Crisis

Here is a very funny video from Paddy Cullivan who first performed this at Kilkenomics 2011. Worth a look.

Kilkenomics 2012 – Economics (comedy) Festival

Here is a promotional video for the recent Kilkenomics festival in Kilkenny Ireland. It brings together top economists and comedians to discuss the perils of the world economy – the debt crisis, the euro, quantitative easing, the environment etc. The clip below shows some of the highlights from last year’s festival – very amusing. Includes Jeffrey Sachs of the Earth Institute Columbia University, Fintan O’Toole author of Ship of Fools and Enough is Enough, Will Hutton of The Guardian and a range of comedians.

Anatomy of an Irish bubble

Michael O’Sullivan wrote an interesting chapter in “Understanding Ireland’s Economic Crisis” about Ireland’s bubble. He talked about the anatomy of a bubble and went through various examples from history. There are 3 stages of the bubble which he describes:

Stage 1 – Favourable shock

The Favourable Shock – in many cases this a change in economic policy or a technological shift. Examples:

The Mississippi bubble – the creation of paper money
Railways booms in the US and UK during the 19th Century
Dot.com bubble – 1990’s
Foreign Direct Investment – Ireland 1990’s

The above events enhance expectations of future economic growth and earning potential. What helps turn the boom into a bubble is the ease of credit – expansionary monetary policy (low interest rates), relaxed lending conditions etc. This then leads to rising asset values which allows corporate and the household sector the ability to take on more debt (leverage). In Ireland real interest rates (Interest rate – CPI) was 0% in 1998-2001 and was approximately -4% in 2000.

Stage 2 – Speculative growth

The Speculative Stage is one where the ecstatic enthusiasm for risk chases high returns and investment becomes speculation. A quote from J.M.Keynes describes the change in mood:

As the bubble gains momentum some people come to believe there is a greater fool who would buy their inflated assets. With this aura of confidence and supporting arguments from the periphery – e.g. “the world has changed” or “this time it’s different” – a mood of speculative optimism becomes rampant. An example of this positive rhetoric was from former Irish Taoiseach (Prime Minister) Bertie Ahern. He stated that those warning of the property bubble should “commit suicide”.

Stage 3 – Irrational Exuberance

Irrational Exuberance starts to dominate the “herd” and often this stage sees the sharpest and most bewildering rise in asset prices. However, there comes a time when this sort of frenzied activity cannot be maintained and eventually the bubble bursts. Most bubbles end with a tightening of monetary policy – higher interest rates – credit controls – limited borrowing potential. For Ireland, as was the case with other economies, the global financial crisis was the “lighting of the fuse”

The Irish Credit Bubble
Morgan Kelly wrote a paper on this and below is a chart from the book “Understanding Ireland’s Economic Crisis” which shows how bank lending assisted the bubble. In 1997 Irish bank lending to the non-financial private sector was only 60% of GNP compared with 80% in most eurozone economies and the UK. By 2008 bank lending grew to 200% of national income. Irish banks were lending 40% more in real terms to property developers alone in 2008 than they had been lending to everyone in Ireland in 2000, and 75% more as mortgages.

A2 Economics – Phillips Curve – an Irish Perspective

Coming from Ireland I took a keen interest in the book entitled “Understanding Ireland’s Economic Crisis” edited by Stephen Kinsella and Anthony Leddin. It is a series of papers written by Irish academics which focuses on the causes of the largest destruction of wealth of any developed economy during the 2007-2010 global financial crisis. One paper on “The Phillips Curve and the Wage-Inflation Process in Ireland” lent itself to the Unit 6 of the A2 CIE syllabus. Remember the Phillips curve:

Bill Phillips, a New Zealander who taught at the London School of Economics, discovered a stable relationship between the rate of inflation (of wages, to be precise, rather than consumer prices) and unemployment in Britain over a long period, from the 1860s to the 1950s. Higher inflation, it seemed, went with lower unemployment. To the economists and policymakers of the 1960s, keen to secure full employment, this offered a seductive trade-off: lower unemployment could be bought at the price of a bit more inflation.

The graphs below show the unemployment and inflation in Ireland between 1987 and 2012.

Notice the following:
1987: – 17% unemployment with over 3% inflation
1988-99: – unemployment falls to 5% and inflation 1.5%
1999-2000: – inflation increases from 1.5% to just over 7%. This increase was largely due to expansionary fiscal policy (demand-pull inflation) and capacity constraints that led to higher costs of production (cost-push). This led to a classic Phillips Curve situation as unemployment was at 4% and the unexpected increase in inflation had caused workers to ask for higher wages. With the low rate of unemployment their bargaining position was very strong.
2001-2004: – during this period we see the typical Phillips Curve wage-price spiral. When there is an unexpected rise in inflation this is accompanied by inflationary expectations and Ireland saw a dramatic upsurge in nominal pay awards. As demand-pull inflation fed into cost-push Irish inflation remained relatively high over the next 3 years.
2005-2008: – with unemployment still around 4% wages continued to rise significantly as inflation remained around the 5% level.
2008-2011: the global financial crisis hits the world economy and unemployment in Ireland hits 15% in the space of 2 years. Meantime the trade-off with inflation starts with the CPI reaching over -6% at the end of 2009. More recently we see inflation getting up to 3% with the rate of unemployment increasing at a diminishing rate.

Although economic indicators are improving in Ireland there is still a long way to go before they can be more confident about its outlook.

Portugese workers told to emigrate – Irish already gone

The high levels of unemployment have led one European leader to suggest leaving the country. According to the FT in London, Portugal’s prime minister, Passos Coelho, has indicated to the younger generation that if they can’t find any work they should “leave their comfort zone” by going overseas. Some from the political left have suggested that although there is a lot more freedom since the dictatorship ended in 1974, this has not translated into opportunities for employment. When Portugal joined the euro in 1999 they became a net importer of migrants but last year it is estimated that 150,000 emigrated overseas and a significant number of them being graduates. As with a lot european countries inflexible labour laws which make it costly to dismiss older workers mean that companies are less likely to employ younger workers. However changing the labour laws to make it easier to get rid of workers isn’t going to go suddenly create more jobs.

In Ireland, since the GFC in 2008, 250,000 people have left the country. What’s more worrying is that the youth unemployment (18-24 year olds) has risen to approximately 33% and that is not taking into consideration those who have emigrated. However to any government youth emigration has some benefits:

1. There is less need for social welfare support
2. It reduces the chances of social unrest which generally tends to originate from the younger members of the population.

Unemployment Figures in Portugal and Ireland

Ireland: model growing economy to model survival economy

Recently a lot has been written about how Ireland could be the model economy of how to overcome a debt crisis by using austerity measures. Interesting to note that in the 1990’s the ‘Celtic Tiger’ was heralded as a shining example of how to run a successful modern economy. Now that the economy has become one of the basket cases of Europe it is ironic that they are, according to Angela Merkel and Nicolas Sarkozy, providing the antidote.

Although the economy is performing better there is still a lot of pain being suffered especially from those who can least afford it – as within most eurzone countries it is the “working” person who suffers the most. However a year after its €67.5bn bailout economic conditions have been improving in the Emerald Isle.

- Exports are up 5.4%
- GDP is up 1.2% in Q2 2011
- Budget deficit is down from 32% of GDP in 2010 to 10% of GDP in 2011

But the bad news is still there:

- Salaries of nurses, teachers, civil servants etc have been cut 20%
- 2012 will see €3.8bn in tax increases and spending cuts
- Retail sales fell 3.8% in October from a year earlier
- Unemployment is now at 14.5%
- The above figure would be higher except for the increasing numbers leaving the country

However although Ireland is making gains in rectifying the economic problems in their economy, it could be all in vain when you consider what might happen to the eurozone.

Central Banks give cheap loans to help global markets

Central Banks worldwide have agreed to provide cheap loans in US$’s to banks in Europe and other parts of the global economy. There is obviously serious concerns about the economic climate in Europe but will it calm the markets? The truth of the matter is that more liquidity alone is not going to solve the economic problmes of the eurozone countries. The graphic below does show some positive signs with bond yields on the way down which suggests that there is less risk associated with their purchase. However there is still a long way to go for stability to return. See graphic below from the WSJ.

Central banks have offered cheaper credit before:
March 2011 – interevened to reduce the value of the Yen following the earthquake and tsunami.
October 2008 – central banks cut rates to reduce the shock on financial markets when Lehman Brothers went under.

“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.” combined statement form the 6 central banks. These include:
-US Federal Reserve,
-Bank of Canada, the Bank of England,
-Bank of Japan,
-European Central Bank and
-Swiss National Bank.

Does Austerity Work?

Recently The Economic Focus column in The Economist had an article that discussed how successful austerity is in generating growth in an economy. Barack Obama said “We have to cut spending we can’t afford so to put the economy on sounder footing and to give our businesses the confidence they need to grow and create jobs”. The UK and the European Central Bank (ECB) are also followers of Obama and argue that cuts to government deficits add to the GDP of an economy. The ECB argues that a fiscal contraction (reduced government spending and increased taxation) may turn out to be expansionary if expectations of lower future taxes and higher lifetime earnings become particularly strong. However, recent research states that this hardly ever happens. A study of 173 fiscal-policy changes in developed economies between 1978 and 2009 showed that cutting a budget deficit by 1% of GDP on average:

* reduces real output by about 2/3 of 1%
* increase unemployment 1/3 of 1%

There have been some cases where economies have grown with the implementation of austerity measures.

Denmark
In Denmark between 1983-86 budget cuts actually led to a rise in domestic demand and consequently GDP. However its economy was already growing at 4% when austerity commenced. Furthermore, interest rates already at 23% came down as the fiscal environment improved. House prices rose by 60% increasing wealth and confidence.

Ireland
Between 1987-89 improved budgetary conditions led to greater growth in the Irish economy. Again, like Denmark, Ireland had high rates of interest (13%) and with a more prudent approach rates dropped as did the Irish currency (the Punt) at the time. This led to an increase in exports by 10% from 1987-90 accounting for most of the growth of the Irish Tiger.

Italy
From 1991 – 1998 budget surpluses were used to pay off debt. But it was Italy’s exit from the Exchange Rate Mechanism (ERM) – see previous post on ERM – that led to a 40% decrease in value of the Lira against the D-mark. Again a weaker exchange rate led to more competitive exports and the Italian current-account went into a surplus and GDP increased.

The success of austerity programmes are characterised by initially high interest rates and weaker currencies which have led to export growth. However, America will struggle to replicate these as:

1 Their interest rates are near 0% already
2 Export volumes will be hampered by weak demand because of debt reduction in other developed nations.
3 Exports only account for a small proportion of their GDP
4 With China holding so much debt in US$ they will not want to see a dollar depreciation.

Higher natural rate of unemployment will mean structural reforms

The recent special report in The Economist looked at the altering structure of the labour market worldwide. Obviously globalisation and technology have brought big changes in the nature of work, and levels of unemployment will remain high in the developed world as developing countries see their numbers employed being boosted.

Edmund Phelps, Nobel Economist, thinks that the US natural rate of unemployment in the medium term is realistically around 7.5% which is significantly higher than a few years ago. Remember the natural rate occurs when inflation is correctly anticipated – this level of unemployment results when the economy is at full employment.

Michael Spence, another Nobel prize-winning economist, agrees that technology is hitting jobs in America and other rich countries, but argues that globalisation is the more potent factor. Some 98% of the 27m net new jobs created in America between 1990 and 2008 were in the non-tradable sector of the economy, which remains relatively untouched by globalisation, and especially in government and health care. Lowering this natural rate will require the following:

1. changing education to ensure that people enter work equipped with the sort of skills required so that there is no mismatch
2. adjusting the tax system – incentivise work
3. modernising the welfare safety net – encourage those to find work
4. encourage entrepreneurship and innovation.

This is easier said than done.

Long-Term Unemployment
This has increased dramatically in many countries – 58% in Ireland, 40% in both Spain and Japan, and 30% in the US, see graph below.

The concern with these figures is that the longer poeple are out of work the less likely there are able to find future employment. There are two reasons for this:

1. Their skills get out-dated very quickly and this is especially prevalent in the current labour market as technology is starting to takeover many procedural white-collar jobs.
2. Motivationally they find it hard to engage in the process of lookign for work and this is esepecially prevalent once a person is on a generous welfare benefit.

According to The Economist:
Long-term unemployment often turns into permanent unemployment, so governments should aim to keep people in work, even if that sometimes means continuing to pay them benefits as they work.

Ireland’s win – Positive Externalities and loads of Consumer Surplus

The game between Australia and Ireland on Saturday night at Eden Park was the biggest upset so far in this RWC. The RWC in New Zealand generally brings pleasure to a significant part of the population. Some will pay to go to games; others will pay to watch it on SKY TV; some will watch it on free to air on TVONE and Maori TV; others will listen to it on the radio; another group will enjoy reading about it in the newspapers. Irish supporters, including myself, will take great pleasure in talking about such a result – lets face it we don’t have much to cheer about at the moment with the state of the economy. What all this alludes to is the fact that as part of this entertainment comes without the public paying for it, the public benefits from an externality.

Those who have flown over for the RWC to support Ireland and went to the game will have no doubt spent a significant amount especially when you consider the state of the euro. Nevertheless the satisfaction (utility) derived in NZ$ from the game would have been much greater than the price they paid for the ticket. This suggest that there is a lot of consumer surplus present – the difference between the price that a consumer WOULD BE WILLING TO PAY, and the price that he or she actually HAS TO PAY. The RWC has been a great success so far and there have been more positive than negative externalities (transport system). Also it looks as if it will be a Northern Hemisphere v Southern Hemisphere final – a positive externality for the IRB? Go Ireland!!!!!

Iceland starts to thaw

The recent OECD* survey on the Icelandic economy paints a rosey picture when you consider what has happened to its economy over the last 3 years. Iceland’s approach has been different to that of the US and Euro Zone counterparts. Instead of introducing policies of quantitative easing and bailouts of banking institutions the Icelandic authorities allowed its banks to fail. Foreign debt, which totaled US$62 billion, left the country with no real choice but to default on the banks’ creditors. This policy has been called “Bankrupting your way to recovery”. In a recent radio interview on the BBC Iceland’s president Olafur Ragnar Grimsson said that Iceland’s approach is about much more than getting the banking sector operational but affirming the will of the people over the financial institutions. Iceland’s GDP for the last quarter is 2% and unemployment is at 5.8% – the latter being high by Icelandic standards.

Compared with the likes of Greece and Ireland who have gone through similar debt problems the one key option with is not open to its eurozone counterparts is that Iceland had its own currency the Krona. As the economy and banking system collapsed so did its currency which has its advantages and disadvanatges.

* The price of visiting Iceland has effectivley halved – Reykjavik was seen as one of the most expensive places to visit as a tourist
* As most of Iceland’s consumer goods are imported this has meant higher prices of cars, food, electronics etc.

Should Greece and Ireland learn from this? According to Stephanie Flanders – BBC Economics Correspondent – Greece already had huge amounts of debt before the crisis unfolded and it doesn’t hold much relevance as Iceland had no public debt at this time. However Ireland, like Iceland, had handled its public finances well but its financial framework poorly.

*Organisation for Economic Cooperation and Development – The OECD provides a forum in which governments can work together to share experiences and seek solutions to common problems.

Germany racing ahead in the euro zone

Since the introduction of the Euro in 1999 the German economy has left its euro zone colleagues behind when it comes to competitiveness and trade revenue. The New York Times produced a worthwhile article showing that Germany’s balance of payments has gone from a small deficit to a strong surplus, but in the euro zone as a whole the balance of payments position has deteriorated slightly. German competitiveness against the rest of the world was probably helped by the fact that the relatively poor performance of other members of the euro zone held down the appreciation of the euro against other currencies – a weaker euro makes German exports cheaper. The graphs below show the German economy against the major euro economies and the troubled euro economies which were forced to seek assistance. However, since the financial crisis, Ireland has improved its position more than any other country in the euro zone, but both Greece and Portugal have continued to lose ground to Germany.

Ireland’s New Tax Form

St Patrick’s Day – Eco Jokes

As it is St Patrick’s Day today (17th March) I thought it might be appropriate to look at the lighter side of economics. Here are a couple of good ones that I have come across:

The new Irish credit rating agency – Moody & Poor (mentioned in a previous posting)

Irish government’s latest policy response to the banking, economic and financial crisis – “Quantitative Cheesing”.

We’ve been downgraded from AAA+ to AA-. What does that even mean? Before, we were a battery for the remote control; now we’re only good for a Walkman?

What is the difference between Ireland and Iceland? One letter and six months

Here is an amusing clip from Russell Howard’s Good News – Irish Economy

“Financial Crisis is not over” – Michael Lewis

Michael Lewis is the author of an excellent book on the financial crisis entitled “The Big Short”. Here he was interviewed by Bloomberg last week and suggests that there is still concerns over the robustness of financial markets and adds his thoughts on the Irish economy. Stories of Bank of Ireland employees chasing Polish workers back to their homeland to collect parking fines – the Poles had left their cars at the airport carpark when they returned to Poland. Some useful economic jargon in the interview also.

In finance, short selling (also known as shorting or going short) is the practice of selling assets, usually securities, that have been borrowed from a third party (usually a broker). The short seller borrows shares and immediately sells them. He then waits, hoping for the stock price to decrease, when the seller can profit by purchasing the shares to return to the lender.

The Big Short: Inside the Doomsday Machine
The Big Short is a 2010 non-fiction book by Michael Lewis about the build-up of the housing and credit bubble during the 2000s. It describes several of the key players in the creation of the credit default swap market that sought to bet against the bubble and thus ended up profiting from the financial crisis of 2007–2010. The book also highlights the eccentric nature of the type of person who bets against the market or goes against the grain. The work follows people who believed the bubble was going to burst, like Meredith Whitney, who predicted the demise of Citigroup and Bear Stearns; Steve Eisman, an anti-social hedge fund manager; Greg Lippmann, a Deutsche Bank trader that created the first CDS market by matching buyers and sellers; the founders of Cornwall Capital, who started a hedge fund in their garage with $100,000 and built it into $120 million when the market crashed; and Dr. Michael Burry, an ex-neurologist who created Scion Capital despite suffering from blindness in one eye and Asperger syndrome. Wikipedia

A country song about the crisis in Ireland

Here is another great song from Merle Hazzard who wrote and sung Double-Dippin an earlier post. Here he sings about the crisis in Ireland to the tune of that famous Irish song Danny Boy. There are more songs on his website – Merle Hazzard

The Euro can rise again

It seems that the Euro countries are living in denial. Surely some of them – Portugal, Ireland, Greece, Spain (PIGS) are going to have to give up the Euro within the next couple of years. Politicians insist that there is no legal mechanism to exit the Euro but according to Charles Calomiris – a Professor at Columbia Business School – the collapse of the Euro is simple arithmetic. When a country has a debt-to-GDP ratio high enough, it becomes impossible for it to generate enough future taxes to repay its existing debt and interest costs. The only alternative for countries in the above condition is to default on their euro-denominated debt and exit the Euro. Then they can finance their fiscal deficits by printing their own currency.

Long-term planning
The challenge today is to plan for a sustainable currency union in the future, once exiting countries reform themselves enough to rejoin. It is imperative that the Eurozone countries agree on measures to prevent massive deficits. One of the reasons that Italy and Greece spent so much is that their interest rates fell dramatically when they joined the Eurozone, making deficit finance more attractive. The too-big-too-fail problem is both dangerous and avoidable – better to let the banks fail. Politicians today are frightened of transparency in the recognition of bank losses and are often unwilling to close insolvent banks losses

2011 Black Swans

A few days have past since my last post – had another spell at the beach with family before heading back to Auckland. Anyway Bernard Hickey wrote a nice piece on the NZ Herald website today with regard to Black Swans.

No doubt you would have come across the book entitled “The Black Swan” (2007) by Nassim Nicholas Taleb. He describes a black swan as highly improbable event with three principal characteristics:
1. its unpredictability;
2. its massive impact; and
3. after it has happened, our desire to make appear less random and more predictable than it was.

Nassim Nicholas Taleb could see the banking crisis being realized, and this quote from “The Black Swan” explains partly the rationale for the current environment. Remember it was written when the world was awash with cheap credit and leaders were content with what was happening.

“So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks – when one fails, they all fall. The increased concentration among banks seems to have the effect of making financial crises less likely, but when they happen they are more global in scale and hit us very hard. We have moved from a diversified ecology of small banks, with varied lending policies, to a more homogeneous framework of firms that all resemble one another. True, we now have fewer failures, but when they occur I shiver at the thought.” Page 225-226

2011 – Black Swans

Hickey mentions the following in his piece:
* Irish Politics – with a likely change of government there is the probablity that holders of Irish bonds will suffer losses and subsequently put pressure on UK and German banks
* Chinese inflation – with pressure on prices there could be social unrest as lower income groups grapple with the cost of living
* Aussie house prices – already depressed in Queensland, Sydney and Perth this could mean lower volume of imports from NZ
* Higher oil prices – conflicts in the Middle East could lead to supply pressures
* Kiwis stop spending – still a lot of debt around and deleveraging.

A couple of my predictions for 2011

* US Fed goes for QE3 – Quantitative Easing No. 3 – as the banks once again get into trouble
* Gold hits US$1,700 an ounce as investors run for cover
* Reserve Bank of New Zealand maintain their expansionary stance and don’t increase interest rates until September
* Ireland win the Rugby World Cup

EU leaders need a geography lesson

Back into it after an enjoyable week at the beach. Satyajit Das has an interesting post on the blog Naked Capitalism concerning the crisis in Europe. He states that EU leaders have issues with their geography and before giving in to the unavoidable:

*Ireland told everyone that they were not Greece.
*Portugal is now telling everyone that it is not Greece or Ireland.
*Spain insists that it is not Greece, Ireland or Portugal.
*Italy says it is not in the “PIGS”.
*Belgium insists it was no “B” in “PIGS” or “PIIGS”.

Russian writer Leo Tolstoy wrote that: “All happy families resemble one another, every unhappy family is unhappy in its own way.” The same applies to beleaguered European countries.

Greece had a bloated public sector and an uncompetitive economy sustained by low Euro interest rates.
Ireland suffered from excessive dependence on the financial sector, poor lending, a property bubble and an increasingly generous welfare state.
Portugal has slow growth, anaemic productivity, large budget deficits and poor domestic savings.
Spain has low productivity, high unemployment, an inflexible labour market and a banking system with large exposures to property and European sovereigns.
Italy has low growth, poor productivity and a close association with the other peripheral European economies. Italy has recently started to rein in its budget deficit. The Italian banking system is relatively healthy but exposed to European sovereign debt.
Belgium is really two ethnic groups that share a king and high levels of debt (about Euro 470 billion, 100% of GDP).

Click here for the full posting.