Friday, June 21, 2013

21/6/2013: Most Important Charts in the World, June 2013

Business Insider produced another set of charts, under the usual heading of "Most Important Charts in the World": http://www.businessinsider.com/most-important-charts-in-the-world-2013-6#

Obviously (shameless self-promotion alert) number 22 worth a look...
http://www.businessinsider.com/most-important-charts-in-the-world-2013-6#constantin-gurdgiev-trinity-college-dublin-its-going-to-take-a-long-time-to-pay-off-eurozone-debts-22

Here it is reproduced from my file:
You can click on the image to enlarge.

Note, the same relationship exists for Government debt or Household debt taken alone and the individual relationships are actually even stronger (adjR2 in the range of 43-44% against 38% for the combined debt relationship).

21/6/2013: Dukascopy TV interview

My interview with Dukascopy TV, Switzerland on Fed's FOMC and monetary policy dilemma, G8 and its implications for Europe and Ireland, and the Russian economy: http://www.dukascopy.com/tv/en#104517 and http://youtu.be/ir9701EHeOU


21/6/2013: McKinsey Economic conditions Survey for H2 2013

Couple of interesting charts from the McKinsey Survey on global economic conditions (see full set of results here: http://www.mckinsey.com/Insights/Economic_Studies/Economic_Conditions_Snapshot_June_2013_McKinsey_Global_Survey_results?cid=other-eml-alt-mip-mck-oth-1306)


So the percentage of those who are saying the global economy is performing substantially better at the end of Q2 2013 is 36%, which is down on 43% in Q1 2013, signalling deterioration in the conditions. Percent of those who see any improvement in the global economy is down from 79% to 75% q/q. In terms of expectations forward:

Things are not going all too well in expectations 6mo forward either. 41% of all respondents are upbeat in expecting an improvement in global growth of H2 2013. Now, keep in mind, most of the official forecasts factor in significant uplifts in economic conditions in H2 2013 to deliver on annual targets set for 2013 at the end of 2012. Let's take a look at regions where H2 expectations were the most optimistic on the official side: 49% Eurozone executives expect things to improve, Asia-Pacific (especially China) 38% and North America 32%. Hmmm... nowhere over 50%. Sample biases are probably working toward reporting firms having more robust expectations, as the survey covers larger companies, with bigger investment pipelines, usually consistent with upside to expectations.

For their own countries:


Better vs Same/Worse percentages:

  • Asia-Pacific: 42% vs 59% in Q2 2012, against 38% vs 61% in Q1 2012. Own-country conditions confirm a 'no expansion' expectation in H2 2013
  • Developing markets: 35% vs 64% in Q2 against 47% vs 53% in Q1. Own-country conditions confirm a 'no expansion' expectation in H2 2013
  • Eurozone: 32% vs 68% in Q2 against 34% vs 66% in Q1. Own-country conditions confirm a 'no expansion' expectation in H2 2013
  • India: 45% vs 55% in Q2 against 60% vs 40% in Q1. Own-country conditions confirm a 'no expansion' expectation in H2 2013
  • North America: 54% vs 46% in Q2 against 43% vs 57% in Q1. Own-country conditions confirm a 'expansion' expectation in H2 2013
So of all regions, with exception of North America, own-executives signal no gains in growth in Q3-Q4 that is assumed ex ante in the official forecasts... time to go 'hmmmm...'

21/6/2013: Europe's Capacity Deficit Illustrated

Want an example of Europe's 'capacity deficit' I mention here: http://trueeconomics.blogspot.ie/2013/06/1962013-european-federalism-and-emu.html

Look no further than the latest set of quotes fired off by ECFIN E-news letter:


Let's take them through reading.

Mr Rehn says that 'Banking Union is not about bailing banks'. Of course he is right - the EU has bailed out the banks before it conceived the EBU. However, one major objective of the EBU is about systematising future bailouts of the banks, in theory - to restrict taxpayers' expected liabilities in such bailouts, and to regulate future depositors' liabilities. And EBU is - according to the EU Commission and the ECB - a necessary element of the sovereign-banks 'break' that includes ESM. Now, ESM is about bailing out the banks.

Is EBU 'about getting a banking system that serves the real economy'? Well, nothing in the EBU proposals so far has much to do with the 'real economy' in a positive sense of serving it. At least nothing that requires an EBU and cannot be done absent EBU. Deposits insurance? Doesn't need an EBU. Joint supervision and regulation? Hardly much to do with the real economy, unless one is to make a claim that the two are fail-proof way of ensuring that a new crisis won't happen. In fact, when it comes to the real economy, the EBU is a part of the policy instruments package that includes depositors  bail-ins, mechanism for sovereign liabilities imposition and fiscal harmonisation - these are about the real economy, but there is little in terms of 'support' here. More like 'limiting damage' by 'spreading the cost'. Reality check: UK has an EBU equivalent, US and Japan have one... all had banking crises that cost their real economies dearly...

So Mr Rehn is just plain propagandising, right? Well, sort of - the EBU is a necessary, but not a sufficient condition for the survival of the Euro. If you accept the thesis that Euro's survival is the 'service' that real economy needs, then you have 1/2 of Rehn's equation there.

Onto Mr Lamy who says that Europeans need something new to drive their attention away from the bad things that are old. Contemplating the past is disuniting the peoples of Europe. Giving them something new to desire (may be a promise of a new iPad for everyone would work?) will shift them to work toward the future, presumably forgetting and forgiving the past and the present. How did the Soviet leaders not think this one up? 'We promise you this better future because we screwed up your past and present' school of politics...

Ireland's Taoiseach is honestly thinking that EBU is necessary to give credibility to European leaders because they promised EBU. Neither the concept of 'do we need A in the first place', nor the irony of his party pre-election promises not being delivered on strike Mr Kenny as being a touch testing. And then there's 'following through on decisions is the very least our citizens expect and demand'. Not really. Citizens demand that political leaders (a) adopt right decisions, then (b) implement right decisions. Having not established that EBU is right fails both (a) and (b).

But the most priceless bit of Mr Kenny's statement is that he believes that something is crucial because it is a credibility test. Mr Kenny's logic here is risking a resemblance to a schoolboy's logic who, in fear of hearing 'Chicken! Chicken!' from a schoolyard bullies heads off to carrying out a silly and dangerous deed, lest his 'credibility' be challenged.

This, per the EU's powerful, is 'leadership' at the time of a crisis?..

Thursday, June 20, 2013

20/6/2013: Real Price of Gold (and fiat currency by implication)

Price of Gold since 1791 in constant 2012 USD:

Click on chart to open

And a data set for gold prices since 1257: http://measuringworth.com/gold/#

You can't really make a data set for any fiat currency since 1257, cause none really exist anymore... though you can make sets of numismatic values of some. So risk-adjusted value of gold is X>0 over any time horizon. Risk-adjusted value of any fiat currency over much of the historical time horizon is X~0. That is, of course, if unlike Keynes you do believe that the long-run matters...

20/6/2013: Heroes of our times and earnings...

Latest data on (annual) earnings, to highlight the vast gains in Irish 'competitiveness'

And the heroic folks who earned a 4.2% (second highest) earnings premium are... well... see below:


http://www.cso.ie/en/media/csoie/releasespublications/documents/earnings/2012/earnlabcosts2012.pdf has more on the same...

20/6/2013: China Volcano Blowing Up at Last?

Good title to a research note, as I tell my students in MSc in Finance, does the following things:

  1. Captures attention of the reader for the right reason
  2. Conveys enough information for the reader to continue reading, but not enough to end up with a feeling that all that needs to be known is already expressed in the title
  3. 'Sells' the story without over-exaggeration
  4. Commits the story to memory.
Today's 'good title' award is for the folks from Markit, for the note titled "Perfect Storm" - a simple, run of the mill account of the day when Asian CDS markets got bashed on China's end of things:


And while on China, excellent article in the FT today on Chinese steel giant Wisco: http://www.ft.com/intl/cms/s/0/fa98c4e2-d830-11e2-9495-00144feab7de.html
Read and weep... China has managed to perfectly waste a USD586 billion stimulus from 2008. That's a lot of burning of cash, if you ask me.

Here's mid-day CDS wideners by order of magnitude:

And here's yesterday's:
That's 40bps in two days. Whacking-cracking... 

On June 6th, China's CDS were at 91.61 with CPD of 7.71%. Chinatastic...

And with that China is heading for a classic sugar crunch just as the punch run out. Over the last three weeks, China's interbank loans rates jumped from about 3% to over 7%, having hit last week 9.6%.

Someone, dial Bank of Japan, quickly!

20/6/2013: Some facts about income inequality in Ireland and across OECD

Here's an interesting chart from the OECD's latest analysis of income inequality changes during the crisis:

Chart: Market income inequality rose considerably (Percentage point changes in the Gini coefficient of household market and disposable incomes between 2007 and 2010)



While Ireland ranks 1st in terms of overall gross income inequality increases during the crisis (primarily driven by the changes in the employment composition by tenure during the recession and the asymmetric recovery/price dynamics in assets markets between property and equities), we rank 9th in terms of after-tax disposable income inequality. Put differently, tax hikes did impact disproportionately those better off, so much so, they offset asymmetric income changes (including for income from assets).

This effect is partially reflected in the chart below:

Chart: Taxes and social transfers mitigated falls in market income in most OECD countries (Annual percentage changes in household disposable income between 2007 and 2010, by income component)


As things stood in 2010 (major caveats apply here), Ireland's levels of income inequality are actually below the OECD average:

Chart: There are large differences in levels of income inequality across OECD countries (Gini coefficient of household disposable income and gap between richest and poorest 10%, 2010)

Although our income inequality is above that for all EU countries, save Italy, Estonia, Greece, Spain, UK, and Portugal. In comparative across the English-speaking OECD states, we are ranked in the 1st place in terms of having the lowest levels of income inequality.

Loads of fascinating analysis on the topic here: www.oecd.org/els/soc/OECD2013-Inequality-and-Poverty-8p.pdf


20/6/2013: FTT: Extra-territoriality and Stamp Duty Comparative


An important piece of analysis of the European Financial Transactions Tax (FTT or 'Robin Hood' Tax) by Clifford Chance from January this year.

The importance here is in detailed note on application of the FTT as contrasted with existent stamp duties (see page 3) and the extra-territorial nature of the FTT (see page 2).

Link: http://www.cliffordchance.com/publicationviews/publications/2013/01/the_new_eu_financialtransactiontaxwhyi.html

Link to the previous post on FTT: http://trueeconomics.blogspot.ie/2013/06/1462013-eus-ftt-one-tax-multiple.html

20/6/2013: Stalled Irish Banks Reforms: Sunday Times, June 16, 2013


This is an unedited version of the Sunday Times article from June 16, 2013


The latest data from the Central Bank shows that in two years since the current government took office, Irish banking sector is not much closer to a return to health than in the first months of 2011.

Objectively, no one can claim that the task of reforming Irish banking sector is an easy one. However, credit and deposits dynamics in the sector point to the dysfunctional stasis still holding the banks hostage. Despite ever-shrinking competition and vast subsidies extended to them, Irish banks are not investing in new technologies, systems and models. Banks’ customers, including businesses and households, are thus being denied access to services and cost efficiencies available elsewhere. In short, the Government-supported model of Irish banking is failing both the sector and the economy at large.


In April this year, total inflation-adjusted credit advanced to the real domestic economy, as measured by loans to Irish households and non-financial corporations, stood at EUR175,419 million. Since Q1 2011, when the current Government came to power, real credit is down EUR32,302 million. This figure is equivalent to roughly twice the annual rate of gross investment in the economy in 2012. Total credit to non-financial corporations has now been in a continuous decline for 48 months.

Half of this contraction came from loans over 5 years in duration. These loans are more closely linked to newer vintage capital investment in the economy, generation of new jobs, R&D and innovation activities, as well as new exports, than loans with shorter duration. Let’s take this in a perspective. The fall in total longer duration lending since mid-2009 is equivalent to losing 70,000-90,000 direct jobs. Factoring in interest income plus employment-related taxes, the foregone credit activity has cost us close to the equivalent of the tax increases generated in Budgets 2012-2013.

It would be fallacious to attribute credit supply declines solely to the property related lending. Based on the new data reported this Thursday by the Central Bank, loans levels advanced to private enterprises have fallen, between Q1 2011 and Q1 2013 in all sub-sectors of the economy, with largest loans supply declines recorded in domestic, as opposed to exports-oriented, sub-sectors.  All loans are down 6%, while loans to companies excluding financial intermediation and property related sectors are down 5.8%.

However, on the SMEs lending side, some of the steepest loans declines came from the exports-focused enterprises, such as ICT sector, where credit has fallen 9.7% on Q1 2011, or in computer, electronic and optical products manufacturing where loans are down 6.5%. Even booming agriculture saw credit to SMEs falling 5.7% over the last two years, while credit for scientific research and development is down 13.3%.

The picture is, in general, more complex for the levels of credit outstanding in the SMEs sector. On the demand side, in Ireland and across the euro area, there has been a noticeable worsening in the quality of loans applications filed with the banks during the crisis. In a research paper based on the ECB SAFE enterprise level survey data for euro area SMEs, myself and several co-authors have identified the problem of selection biases in companies’ willingness to apply for credit. In simple terms, SMEs more desperate for funding due to deteriorating balancesheets are more likely to apply for credit today. In contrast, healthier firms are more likely to avoid applying for bank credit.

ECB data also shows that Ireland’s problem of discouraged borrowers is much worse, than the euro area average. For example, in Ireland, 21% of all SMEs that did not apply for credit stated that they did so for fear of rejection, almost 3 times the rate of the euro area average and nearly double the second worst performing economy – Greece.


On the funding side, Irish banks have been and remain the beneficiaries of an unprecedented level of funding support compared to their euro area counterparts.

A recent research paper from the Dutch think tank CPB, titled "The private value of too-big-to-fail guarantees" showed that through mid-2012, the pillar banks in Ireland have availed of the largest subsidy transfers from the sovereign and Eurosystem of all banking systems in Europe. Funding advantages, accorded to the largest Irish banks, alone amounted, back in June 2012, to more than double the share of the country GDP compared to Portugal, and more than seven times those in Spain and Italy.

Removal of the explicit Guarantees was supposed to serve as a major step in the right direction. Alas, Irish pillar banks continue to depend for some EUR39.5 billion worth of funding on Eurosystem.  The latest Fitch report on the pillar banks shows that this reliance is likely to persist as loan/deposit ratios remain relatively high. Latest figures put Bank of Ireland, AIB and PTSB loan/deposit ratios at around 120%, 130%, and over 200%, respectively.

And there are further issues with funding in the system. By mid-2014, AIB is required to raise EUR3.5 billion to redeem the preference shares held by the National Pension Reserve Fund. Bank of Ireland will have to find EUR1.8 billion for the same purposes. In both cases there are questions as to how these funds can be secured in the current markets without either further reducing money available for lending or tapping into taxpayers’ funds.


Subsidies to the ‘reformed’ Irish pillar banks go hand-in-had with the regulatory protectionism, which completes the picture of massive transfers of income from the productive economy to the zombified banking sector.

Since 2008, Irish financial services continue to experience ongoing process of consolidation and, underlying this, the reduction in overall competition. Data from the ECB shows that the number of financial institutions operating in the country has fallen in 2012 to the levels below those recorded in 2000-2008. Dramatic declines in the fortunes of the third and the first largest lenders – Anglo and AIB - should have led to a drop in the combined market share held by the top 5 banks. Instead, the market share of top 5 credit institutions rose over the years of the crisis.

To a large extent, this reflects exits of a number of foreign lenders from the market. However, unlike in the case of the US and the UK, there are no new challengers to the incumbent players in the Irish asset management, investment, corporate and merchant banking, and credit unions sector. Neither the regulators, nor the banks have any incentives to encourage new players' entry.

And this has direct adverse impact on the overall health of the economy. When we studied the effects of banking sector concentration on firms’ willingness to engage with lenders, we have found that higher concentration of big banks’ power in a market is associated with lower applications for credit and higher discouragement.

As the result of the reforms undertaken in the Irish banking sector, our banking services are left to stagnate in the technological and strategic no-man's land.

Mobile and on-line banking systems remain nothing more than appendages to the existent services, with only innovation happening in the banks attempting to force more customers to on-line banking to cut internal costs.

Currently, worldwide, banking services are migrating to systems that can facilitate lower cost customer-to-customer transactions, such as direct payments, e-payments, peer-to-peer lending, and mixed types of investment based on combinations of equity and debt. All of this aims to reduce cost of capital to companies willing to invest. Irish financial services still operate on the basis of high-cost traditional intermediation and the Government policy is to keep hiking these costs up. Instead of moving up to reflect the true levels of risks inherent in Irish banks, deposit rates for non-financial corporations and households are falling. Interest on new business loans for non-financial corporations is up 105 to 197 basis points in April 2013, depending on loan size, compared to the average rates charged in Q1 2011. Over the same time, ECB policy rates have fallen by 75 basis points. This widening interest margin is funding banks deleveraging at the expense of investment and jobs.


Combination of the lack of trust in the banking system, alongside the lack of access to direct payments platforms means that many businesses in Ireland are switching into cash-only transactions to reduce risk of non-payments and invoicing delays. Currency in circulation in Ireland is up 10.3% on Q1 2011 average, while termed deposits are down 6.3%.

With big Pillar Banks unable to lend and incapable of incentivizing deposits growth, we should be witnessing and supporting the emergence of cooperative and local lending institutions. None have materialized so far. If anything, the latest noises from the Central Bank suggest that the credit unions can potentially expect to take a greater beating on the loans than the banks will take on mortgages and credit cards.

All-in, Irish banking system is far from being on a road to recovery so often spotted in the speeches of our overly-optimistic politicians and bankers. The credit squeeze on small businesses and sole traders is likely to continue unabated, and with it, the rates of business loans arrears are bound to rise.





Box-out:
In this month’s survey of economists by the Blackrock Institute some 64% of the respondents stated they expected euro area economy to get e little stronger over the next 12 months and none expected the recovery to be strong. In contrast, 74% of respondents thought German economy will get better and 81% forecast the same for the UK. In the case of Ireland, however, only 57% of respondents expected Irish economy to become a little stronger in a year through June 2014 (down on 75% in May 2013 survey). None expected this recovery to be strong. Interestingly, 69% of respondents describe Irish economy's current conditions as being consistent with an early or mid-cycle expansion - both normally consistent with above-trend rapid growth as economy recovers from a traditional recession. Thus, the survey indicates that majority of economists potentially see longer-term prospects for the Irish economy in the light of slower trend growth rates. Back in 2004-2005, I suggested that the Irish economy will, eventually, slowdown to an average rate of growth comparable to that of a mature small euro area economy. This would imply an annual real GDP growth reduction from the 1990-2012 average of 4.9% recorded by Ireland, to, say, 1.8% clocked by Belgium. Not exactly a boom-town prospect and certainly not the velocity that is required to get us to the sustainable Government debt dynamics.

Wednesday, June 19, 2013

19/6/2013: European Federalism and EMU Experience



There is a number of flaws in the euro area design that were exposed by the current crisis. Perhaps the most fundamental is the flaw relating to the system complete incapacity to generate critical capacity. Despite the crisis continuing for the 7th year in a row, the EU and the euro area as its core sub-set remains unable to ask the key question of viability of the social, political and economic project based on the premise that ever-increasing levels of policies and institutions integration, harmonisation and coordination is a feasible and a desired direction to pursue.

Let's start from the top.

Firstly, it is now pretty much an accepted wisdom that in shaping the EMU, European leaders have failed to see even the basic implications of deep integration. The implications missed were not just monetary or economic. Current crisis has shown deep divisions within the euro area on matters such as inflationary preferences, expectations formation mechanisms, conditionality evaluations and fiscal transfers, all cutting across social and cultural division lines, rather than purely economic ones. This failure has led to the design flaws that are principles-based and, as such, cannot be corrected by managerialist solutions. They require structural change - a matter of concern for Europe, so far incapable of following through with even managerialist changes, such as adherence to well-specified Maastricht Criteria targets at the times of aplenty or expression of any solidarity at the times of constraints. There is little hope the EU can deliver on much less defined, broader and, at the same time, culturally and socially more challenging reforms and changes required to move the euro project forward, away from the danger zone.

Secondly, it is also pretty clear that the EU institutions are incapable of learning from the mistakes of their leaders and from the signals transmitted from the nation states and the electorates. Instead of making an effort to understand the underlying causes for a rushed, poorly planned and poorly executed monetary policy harmonisation, the EU leaders are now jumping head-in into attempting to cure the sever hangover from the common currency creation by doing more of the same - embracing the idea of banking and financial services integration (the Banking Union - EBU) and political consolidation (the Political Union - EPU).

A combination of the two directions will, under these conditions, risk leading Europe toward a repeat of the EMU fiasco on a much grander scale - a failure of all three 'unions' - the EMU, the EBU and the EPU. History can repeat itself, having shown its hand today as a structural crisis in one area of the system, with a replay of the crisis across the entire system.

There are number of reasons for this conjecture.

The EU's latest drives - across political and banking dimensions - into deeper integration are lacking the deep foundations on both, the demand and supply sides of their respective equations. In this, they are  exactly mirroring the EMU creation that too faced the original minor crisis in the 1990s only to be pushed through in the noughties.

In case of the EPU, the lack of these foundations is even more fundamental than in the case of EMU or EBU. EPU has no political legitimacy and is losing any potential future legitimacy on a daily basis. EU institutions and even the core ideas of the later-stages EU (EMU, Fiscal Compact, 6+2 Pack packages of legislation etc) are deep under water when it comes to popular mandates. All Eurobarometer surveys show rising dissatisfaction across the EU with the European institutions, including the common currency. The two words 'democratic deficit' that were present in the European politics prior to the crisis are now, probabilistically-speaking, dominate the popular and national discourse about Europe in every country of the Union, including the new Accession states. A popular mandate in Iceland has led to cancellation of the EU Accession talks this month.

Only doctrinaire Europhiles, and even then, predominantly within smaller countries' national elites, as exemplified by some members of Ireland's ruling coalition, today deny the presence of this deficit at the fundamental level across all European institutions.

There is also a major problem of Europe's 'capability deficit'. Brussels - full of (mostly) men in suits with offices to go to after lunch is hardly a source for inspiration or for leadership. And absent inspiration, perspiration does not work all too well. The entire European project lacks vitality, and thus - viability. There is no enthusiasm, no ideal, no dream. These were exhausted at the stages in the project history when 'peace between France and Germany' had meaningful referential counter-point (it no longer has, as no one sane enough would conjecture that absent the EU, Alsace will be once again dug into an anti-tank trenches giant washing board) or when the EU (brilliantly and correctly) was expanding the liberty of trade and freedom of movement across its internal borders. Absent purpose, leadership is wanting too. The void is filled with simulacra of bureaucrateese: the alphabet soup of 'programmes' such as ESM, EFSF, EFS, OMT, EBU, and so on, all the way until ordinary European gets lost in the world of corridors, meeting rooms, windowless conference venues, meaningless letters and mumbo-jumbo of various white papers, etc.

To confront these deficits, the EU is creating even more bureacrateese - papers, positions, plenaries, meetings, councils, pacts, compacts, conferences, agendas.

Amidst this, Europe still lacks a single face capable of holding its own in front of the electorate. Lacks, that is, on the 'federalist' or pro-EU side. There are rhetorically competent MEPs on the opposition side of the chamber, but there is not a single appointed or elected leader of the 'official' Europe capable of not putting to sleep at least half of his/her audience.

Europe has 4 'Presidents' today: President [of the Commission] Mr Jose Manuel Barroso, President [of the Council] Herman von Rompuy, President [of the Parliament] Martin Shulz, President [of the Eurogroup] Jeroen Dijsselbloem. Absent the latter one, not a single one have been known for talking straight on any hard issues. Including the latter one, none inspire many to anything akin the commitments and sacrifices required to achieve meaningful federalisation of the EU. All, with no exception, got their EU positions bypassing direct election by the voters of Europe. Power and responsibilities of each are directly proportional to the distance by which they are removed from the European electorate. When these levels of confusion and power politics dispersion are not enough, there's always a fifth President lurking around: the Head of the Presidency State. In Henry Kissinger's terminology, the question is not 'Who do you call when you want to speak to Europe?' can now be replaced by 'Who do you not call?' Latest G8 summit photos stood as a great exemplification of the problem: there amidst leaders of 8 nations stood three 'leaders' of Europe, not because they had anything to say, but because they had to be there to upstage one another.

The five-headed 'leadership' beast is now on a quest to 'increase democratic mandate' of the EU Commission. To do so, it is proposed that the blocks of parties shall be formed in the EU Parliament to 'nominate' the next Commission and its President. In other words, the EU leadership sees 'renewal' and 'democratic participation' as a function of optics. Dominant blocks of largely sclerotic national-level parties will be dominating the EU legislature and executive to simply replicate the stasis that has captured national political platforms of the main EU states: Germany, France, Italy and Spain. Effective opposition will remain impossible, just as it remains today, but the fig leaf of 'more direct' ('slightly less-managed') democracy will act to cover this up from, hopefully, oblivious or satisfied electorates.

Thus, by design from above (not by will from below), the EU is supposed to move toward a two-party system, replicative of the traditional core parties of the national politics: the centre-left with a clientilist base in unions, state employees and 'social pillars' - the 'social democratic centre'; and the centre-right with a clientilist base of 'employers confederations' and state managers - the 'populist & conservative movements'.

The dynamism of such a system will be equivalent to the excitement of a turtles race on sticky putty. Or differently, a two-party system will do for the political leadership what the Euro did for the monetary policy - put a straightjacket of superficial conformity onto the society that for centuries was based on differentiation-driven boundaries and nation states.

Both demographic and socio-economic changes from the 1945 through today, in Europe as elsewhere, have meant emergence of more diversity and differentiation in markets for everything, starting with simple products, such as diapers to complex services, such as healthcare. To assume that politics and ideologies can remain in the stasis of the two, adjoining at the centre and even overlapping, sets of ideals and policies is about as naive and counterproductive as it was to assume that Greece and Finland, or Latvia and Portugal, can be brought into single currency within a span of one/two decades.

There are three key ingredients that are required to sustain two-party system: 1) stability of ideological preferences (informed by popular objectives for policy), 2) allegiance to the single unifying institution of the state overriding local/national/ethnic or even more atomistic allegiances and interests, and 3) organic evolution of the two-party system (usually out of the bifurcating economic power balance, such as land-owners vs capital owners, workers vs capital owners etc).

Modern world, especially the world of Europe, does not support either one of these preconditions. Current conflicts and, thus, incentives lines are drawn across generations; skills groups; risk-taking capabilities and preferences of populations; national and even sub-national distinctions; ethnic, historical and cultural differences and grievances; external threats that range across a very wide spectrum from immigration from the South to hegemonic threat from the East, to cultural threat from the West, and so on. Two ideologies can never capture this diversity, let alone provide a sufficient basis for forming participatory democratic institutions. Look no further than internal nation states' dynamics in the UK (Scotland, Norther Ireland, Wales), Italy (North, South, East), Spain (Centre, North-East, North-West), Belgium, and recall the fate of Czechoslovakia, Yugoslavia. Look at the emergence of challengers to the two-party systems in all European states - never quite capable of displacing one of the parties of the 'old' system, but always present, reflective of the ongoing process of atomisation, or rather customisation of politics.

At the same time, with hundreds of millions spent on propagandising the concept of European citizenship, Europeans remain in deep allegiance to their nation-states, and in many Federal states - to their local 'tribes'. In fact, the EU has been recognising this and reinforcing the locally-anchored distinctions. Culturally, everyday life matters more to the majority of Europeans today that the 'geopolitical' aspirations of Brussels. And culturally, we are living in an increasingly 'goo-cal' world, where trade delivers to us goods and services from all over the world, but we identify ourselves on the basis of goods and services that are local in origin.

In the countries, where two-party system seemingly is stable - e.g. the US and the UK - underneath the surface, the fact that the two-party system fails to capture sufficient percentage of population in an ever-increasingly individualised world is also evident. It is expressed in the stalemate produced by the system where mainstream parties are captive to small minorities of activists and are often torn internally by sub-groups and sub-interests.

Lastly, the two-party system of ideological debate has been shown inadequate in the face of the current crisis.

Looking forward, this failure is extremely significant. In order to work, compared to today's EU, the EPU must be either comprehensive or devolved. On the latter, see below. The former requires significant transfer of power and power base to the EU, implying ca 20% of GDP-sized Federal Government, dominant power of taxation, harmonisation of core public services, such as health, social security, pensions, education. The member states will be allowed some 'gold-plating' of the Federally-set standards, but the standards will have to be set nonetheless. The reason for this is that in a real Federal Union, there will be a functional Transfer Union and that implies standardisation of services funded by transfers. A two-party system will never be able to break away from the sub-national political bases sufficiently enough to deliver such homogenisation.


If European federalism is to evolve, it will have to evolve on the basis of accommodating more diversity, not by homogenising the system by reducing differentiation and fragmentation of the political institutions. It will have to adopt market-like features where turnover of ideas is fast, deployment of solutions (goods and services) is rapid and never permanent, and the system thrives on diversity. This is the exact opposite of the harmonisation and consolidation implicit in traditional federalism, but is rather more consistent with Swiss federalism. The key to this form of federalism is that it severely limits the central powers of taxation and redistribution of resources and vests powers of policy origination, design and implementation in local hands. It also acts to encourage policy heterogeneity - an added bonus in the world of uncertainty, as it allows for creation of policy hedges: a shock impacting different systems differently necessarily shows both the pitfalls and the strengths of various institutions and regulations. In other words, Europe needs less of European centralisation and more of European diversity.

Before this can be delivered, however, Europe needs to systemically dismantle or reduce those institutions that act as an impediment to bottom-up governance - the institutions of centralisation of power.

The first for a review should be the strictest of them all - the euro. Here, the required change will see assisted exits from the euro of non-core states, leaving behind only those countries for which monetary harmonisation makes sense. Most likely these are Germany, Finland, Czech, Austria, and possibly Belgium and the Netherlands. Other countries can revert to their own currencies and/or run open currency system with euro remaining one of the legal tenders in their economies. Belgium and Luxembourg can run in a union with France, if so desired.

The second candidate for restructuring will be the EU Commission. The President of the Commission should be elected on the basis of direct vote with state-based 'electoral' voting system similar to that of the US, to alleviate extremes of population-weighted distribution of votes. The President then can appoint her/his own Commission on the basis of: (1) each member state must be represented in the Commission, (2) Commission candidates can be nominated by member states, the EU Parliament and the President, (3) each member is confirmed independently by the EU Parliament and the Senate.

The third candidate for reform is the EU legislature. The European Parliament should be augmented by the independent, separately elected Senate, based on member states' representation principle and vested with the powers similar to that of the US Senate. The Senate should be directly elected and it should replace the current Council. To strengthen direct links between nation states and the Senate, the formal leaders of the nation states (e.g Italian and Irish presidents) should serve as senators representing their states.

The fourth candidate for reform should be the system of European checks and balances. This should, among others, include a Constitutional ceiling on taxation and redistribution powers.


There are other reforms that will be required. This is hardly a place to attempt to narrate them all. However, the key principle is that the EU needs a drastic reconstruction of its upper levels of legislative and executive powers. And the key question that is yet to be asked and debated (a necessary pre-condition to deriving any solutions) is whether the proposed EPU (and to a less important extent, the proposed EBU) stand a chance of working out any better than the failing EMU?

Tuesday, June 18, 2013

18/7/2013: QE or Not-QE... spot the difference?

My recent exchange with @LISwires on the issue of risks involved in both continued QE and pursuing an exit strategy.


The tweet the started it: "Both are… RT @LISwires: QE is "Treacherous" RT @livesquawk: Roubini: Fed Exit Strategy Will Be 'Treacherous' fw.to/gWL3DCg @CNBC"

Explaining my view that QE & Exit strategies are both consistent with structural and grave risks are:

[Both QE and exit is] like being between a rock and a hard place... inside an iron pipe… Exit = QE = non-QE = stimulus = austerity = disaster. The whole point of a structural depression is EXACTLY that!

In a normal recession, one half of the economy's 'cart' gets stuck in the 'mud'. In a structural depression, the entire cart is in the middle of a quick sand trap.

The ONLY thing that would've worked was direct injection of funds to write down household & corporate debts, & in some cases - restructure sovereign debt too. We missed the boat on this by engaging in LTROs/OMT/ESM/EFSF/ESF/EBU/EMU… stupidity of tinkering along the edges. Hence [having engaged in wasting resources on marginal solutions], from here on - it is vast pain over long term. The choice was made by our 'leaders' in ECB/EU/IMF/National Governments/NCBs.

The real failure of economists/economics is NOT our inability to forecast disasters. It is in our inability to see the size & nature of disaster AFTER it hits.

Note: my reference to the direct recapitalisation solution can be traced to this: http://trueeconomics.blogspot.ie/2010/05/economics-16052010-eu-on-brink.html