Krugman Baltic Bashing 2.0

It would seem that after a tweeter row with Estonian President, Krugman hasn’t had enough fun senselessly putting down Baltic States. In his new blog post, Krugman turns against Latvia in his anti-austerity tirades. While he initially criticized pro-austerity commentators for ‘lionizing’ Estonia as a standard bearer for successful austerity policies, he know seems to believe that Latvia was the lionized example for austerity. Leaving aside Krugman’s inability to decide which austerity policy orientated government is easiest to criticize let’s take a closer look at his accusations.

Krugman quotes Eurostat numbers for real GDP levels, showing that Latvia has had the deepest contraction of the Baltic States, Ireland and Iceland, also showing Latvia having the smallest recovery of pre-crisis level GDP. A few notes must be added to his demonstration. Firstly, both Ireland and Iceland received EU/IMF bailouts to stabilize GDP and also e currency’s value in Iceland’s case, none of the Baltic States received such external inflow of capital to buttress government spending.

Furthermore, both Latvia and Lithuania racked in relatively big budget deficits during the crisis in comparison to Estonia. Why attack the Baltics states least keen on austerity for their austerity policies, why stop talking about Estonia, the real standard bearer for fiscal hawkishness. Again leaving aside this Krugmanesque inconsistency let us look at Baltic States in Comparison to other Euro economies many of which signed on to the G20 pledge for stimulus spending during the crisis.

 Here, seasonably and daily adjusted quarterly per capita real GDP numbers from Eurostat (same source as P. Krugman) tell a different story. This chart shows that while the recession was deep in the Baltic States the recovery was strong, leading all Baltic Nations to have caught to their pre crisis levels (per capita of course) and to the EU as a whole. While Germany, arguably the strongest economy in Europe is above its pre crisis level, there should be no denying that the Ba;tic States chose to bite the bullet early but recover quickly. One wonders if so much can be said for the PIIGS. So without a European bailout Latvia and its Baltic colleagues don’t seem to be doing all that bad. As has been argued before Krugman fails to take into consideration decline population into his thinking when using national GDP numbers. A guess can also be ventured that depending on what time series he chooses to use (constant vs market prices) numbers may vary substantially when evaluating economic performance, no nuancing words from him on that subject.

In any case to better understand recovery dynamics between nations attention must be paid to the depth of contraction as well as the magnitude of recovery. The above chart shows the ratio of real per capita GDP recovery to real per capita GDP contraction. With an EU average a smudge over 1, one can see that the strength of the recovery has been stronger in the Baltic States than in most of Europe. Only the Norther nations of Germany, Austria, Finland, Luxembourg and a few others have been stronger.

So how to explain the difference between austerity in the south and in the Baltic region. The most obvious answer is that states that don’t rely heavily on Government spending during the good times stand to loose less from tight fiscal policy in the bad times. Ireland and Spain do of course buck that trend but the conjecture of their recessions were different in nature than in most of Europe. 

Again it must be repeated that much of the superficial weakness in the Baltic States must be attributed to Europe in general and the rest of the sluggish growth in the World. As export dependent nations they should not be expected to outgrow other regions when there is only week growth in consumption outside their borders. There is however much hope for the Baltic tigers future prospects. As export dependent nations who have refused to transition to internal consumption driven economies, they remain leveraged to an eventual uptick in World growth and are less dependent on foreign capital flows to pay for their growth.

Small open economies the World over should learn from the Baltic experiment that is unfolding and look forward to the next chapter that will surely put stubbornly uncompetitive economies to shame. Let’s hope Krugman can remember his own writings when that happens, so that the rest of us can enjoy his efforts at keeping a straight face when attempting to convince us he was right all along.

Germany Chastises Canada, Sort Of…

Germany reiterated calls today for Canada to participate in the beefing of the IMF funding. The IMF is currently seeking to raise its war chest to 430 Billion dollars in preparation of possible new bail-outs in Europe to serve as a firewall against liquidity contagion of sovereign debt financing. Canadian Prime Minister Stephen Harper and his finance minister Jim Flaherty have resisted demands for the country to participate. While Canada has received praised from Germany for its take on austerity it continues to be admonished for showing little ‘solidarity’ in matters of bailing out Europe.

Harper has repeatedly said that taxpayers in Canada would not participate in financing the welfare state of some of the Richest nations of the World. It must be noted however that Germany is showing a little lack of consistency in its criticism. Much of the political difficulties in the current European sovereign debt crisis stems from Berlin’s refusal to risk its own taxpayer moneys on alleviating required austerity in the Eurozone periphery, so how can Angela Merkel, Germany’s Chancellor, turn around and ask of Canadians what it won’t ask of its own people.

When a country goes bankrupt it makes sense to stabilize that country’s finances and currency through an IMF led debt restructuring with the objective in mind to return that country to a sustainable growth path and government spending. But when the World is faced with the likes of Greece whose sense of state welfare entitlement is so strong that it refuses the policy prescriptions attached to IMF lending, why should the World backstop its governmental spending. European style welfare states require generous taxpayer funding and strong longterm growth to be sustainable, countries desirous of receiving lending from the IMF must accept a model that both generates growth and taxes heavily. For countries to achieve those dual requirements they cannot be hampered by distorted fiscal incentives, which lax IMF lending standards embody.

It should be unacceptable that the IMF, funded by every country in the World including its poorest, should serve as a tool to preserve un merited entitlements in the richest nations of the World. The Conservative governments stand is that the IMF should only serve the Worlds poorest governments, this isn’t right, the World Bank is there to help the poorest, the IMF’s role should be to stabilize the World’s financial system by increasing sovereign liquidity to governments hampered by temporary market pressures.  But Harper is right with regards to who those fledging governments are.

Spain is a prime example of a relatively responsible government facing pressures outside its control and in need of a temporary backstop. Greece however is the antithesis of a responsible nation, underserving of outside help since all its problems are internal. Canada should increase its participation in funding the IMF, but this extra funding should come with conditions. Those conditions should be that the IMF serve strictly the needs of governments willing to accept the longterm rebalancing of their public expenditures, as has been the historical norm. Countries that dither and object to bail-out conditions ex-post, should be blacklisted so that the IMF may concentrate its ressources on countries like Spain who can actually benefit from it and Ireland who has shown responsibility and a willingness to proactively deserve it.

Germany has made many correct economic arguments over the course of the current crisis, let’s hope she can continue to make them consistently going foreword.

Sonnez l’Alarme!

So I keep hearing that Quebec’s fiscal situation is not alarming, that austerity drives are not necessary and that the Jean Charest Liberal government is in the pocket of ‘Big Business’. So I did some snooping around and some number juggling to investigate whether the government’s current drive for a balanced budget is reasonable or just neo-conservative ideological pandering.

So I had to crunch some numbers a little and here is what I have found:

Often you hear people say our situation is not bad we are middle of the pack in the OECD in terms of net debt. Alright so having taken StatsCan’s number’s for Quebec’s net debt than adding on its proportional share of federal government net debt, Quebec indeed is middle of the pack. But who exactly is in the OECD you ask? Well out of 31 countries in the club of developed nations 5 have accepted IMF or EU bailouts (Greece, Hungary, Iceland, Ireland and Portugal). Another 4 countries (Belgium, France, Italy, Spain) have come close to being shut out of credit markets or seen the spead between their yields and comparable safe haven bonds increase to historical highs*. Many more OECD members have seen their long term credit ratings cut since 2007. All this to say that benchmarking ourselves against the OECD is just plain deceptively simplistic. Looking at the chart, one can see that Quebec is also middle of the pack of those that were bailed out. Bigger countries like the US, UK and Germany can get away with higher debt levels, it’s the nature of capital markets to respect bron over brain. However small countries need to be prudent. Ireland and Iceland had very small debt burdens before the crisis and look where they are now: bailed out and battered.

Now that we’ve established that Quebec is part of an unenviable club of high debt small countries, let’s look at its particular situation and find out why people still think things are okay. First sign is bond yields. Quebec’s 2 year bond is yielding ~1.35% or approximately 35 basis points above the Central Banks key rate. In the US the 2 year yield is roughly 27 basis points (at friday march 2nd close) or ~25 basis points above its target rate. So Quebec isn’t borrowing in real terms much more expensively than the US government, allegedly the safest debtor in the World (not that I believe they should be). Another indicator that would suggest no immediate problem is Quebec’s credit rating.

Moody’s	Aa2 (stable)	P-1
Fitch Ratings	AA – (stable)	F1 +
Standard and Poor’s	A + (stable)	A-1 +
Dominion Bond Rating Service	A high (stable)	R-1 (middle)

 None of Quebec’s credit ratings are Prime, meaning Quebec isn’t the safest bet possible but they remain in the High Grade to Upper Medium Grade categories. So one could be forgiven for believing that Quebec is fiscally alright given that large swaths of the financial and capital markets community still respects Quebec’s ability to service its debt. Now you are probably wondering why the ratings agencies are so kind to Quebec. There are many reasons why Quebec might be more financially than the European periphery or developing nations, I’ll focus on the three that seem most important to me (and probably the credit rating agencies):

   Firstly, according to the Canadian Constitution property rights and natural ressources are a Provincial jurisdiction. In essence the Quebec government can legislate any which way it wants with regards to natural ressources. Nationalisation, royalty regime changes and taxation are weapons the government can use to raise revenues or assets. These circumstances are what led the Quebec government to own one of the largest utilities in the World (Hydro Quebec). This coupled with the fact that the Province has a land masse of over 1.5 Million square kilometers containing an abundance of mineral and hydrocarbon ressources puts it a notch above the failing states of Europe in terms of natural wealth endowment.

   Secondly, the province’s government has a relatively high liability coverage ratio. That is for every dollar of debt the government owes it has 51.25 cents of assets as of 2008 compared to an OECD average of 44.91 cents in the same year. Now comparing to the OECD is once again very tricky since some of the members have coverage ratios in the triple digits while others have miserable ratios.

   Lastly, Quebec has an immense advantage over the PIIGS in that, it is part of a functioning monetary and fiscal union. Now functioning is very relative but it works great for Quebec. Quebec’s budget is partially immune to boom bust cycles because some of the automatic stabilizers are federal responsibility. For exemple Unemployment Insurance (called EI in Canada) is covered by the federal government. Quebec is also the recipient of fiscal adjustment transfers. Currently just above 10% of the Quebec budget expenditure is paid for through fiscal transfers from the federal level. This means very simplistically that the government can afford aheftier debt services payments oft least 10% more than its peers (if not much more).

The preceding points and the second graph would seem to imply that the province has the means to pay down its debt and that it has done so since the middle of the 1990’s. However from the third graph (Can & Qc Budget Balances) it is obvious that much, if not all of the heavy lifting in terms of debt consolidation has been done at the federal level. Another factor that has led to a decrease in the overal debt load is the shrinking share of the federal government debt. The data presented here takes into account a generational decrease in Quebec proportion of the debt do to a decreasing share of the population, from 26.38% in 1981 to 23.14% in 2011. The decreasing share of population indicates another problem is present. Quebecers are no longer making babies (okay they still are just not a lot). Quebec is well beneath the population replacement ratio of 2.1 children per woman (~1.5 last I checked, even though we are in the midst of a little echo boom). Which means that the labour participation rate is headed down way down in a near future.

Admittedly that problem isn’t quit immediate and can always be buffered by laxer immigration policy.

Remains the elephant in the room: the gross debt. Not a lot of countries can claim higher gross debts than Quebec without terrifying bond investors or having the IMF knocking on your door. I’ve explained above why this might be, now I’ll explain why it might not last. The bail out situations varied from country to country, but in Ireland and Iceland’s cases it was a question of nationalizing banks then watching the asset side of the balance sheets evaporate, net debt quickly rose towards the gross debt levels. While this isn’t likely to happen to Quebec (most Canadian banks are safe and headquartered in Ontario) it isn’t impossible either. A likelier problem would be a repeat of the Caisse de Depots et Placements 2008 kapoot, when it saw its assets shrink in value, creating a massive unfunded pension liability for the government (one is already present but most actuaires say it is manageable). Mis-management of state enterprises ‘a la Grecque’ or PDVSA style seems quite possible to me in the long run. With Hydro Quebec being the most indebted corporation in Canada (over 35 Billion $) and paying out a heavy dividend to the government its book value should be higher but isn’t. Also not to be neglected is secession from Canada. While politically unlikely now, it wasn’t so long ago that a referendum was won to preserve the confederation by a voting margin of less than 1%.

The bottom line is that Quebec is viewed as stable for a few good reasons, however neglecting the fact that Quebec is as financially precarious and politically unmanageable as some of the worst developed World debt offenders. Buy Quebec debt at your risk, within the next ten years austerity will become an obligation not a choice, I’m not hopeful that our politicians and the citizens they represent will show themselves more responsible than their Greek equivalents.

P.S. Thank you to all those who voted NO to seperation in 1980 and especially in 1995. Quebec would look like a colder version of Greece or Ireland right now if it wasn’t for your assiduousness.

* By “historical highs” I mean Euro era historical highs versus comparable German Bunds yields.

Greece! Go Away!

I sometimes shiver with humiliation at the memories of my adolescence and the utter immaturity that characterized them. I comfort myself with the thought that I have outgrown them. I used to believe that people outgrew their baser adolescent instincts of selfishness, laziness and general disdain for responsibility, I could not phantom the possibility that an entire populace could degenerate into a mindless mob of collective adolescents. Greece has proved me oh so wrong. Now before anybody get’s up and antsy about the broad generalization I recognize that not all greeks are in the streets hooded in black and throwing fiery cocktails around. However, the despairing state of the Greek economy is the business of all those people and the general result of their cumulative collective decisions. The guilty parties are, in no particular order: tax evaders, union leaders and members, politicians, savers, voters, anarchists, socialists, wannabe monopolists, retirees, students and anyone silent on the going-ons of the county. That list I believe covers more or less the majority of the people from the small nation that gave the world democracy.

Reading up on the back and forth between Athens, the Troika and various European capitals I’ll admit to a sinking feeling of despair. Berlin’s demands just keep mounting and the absurdity of Greek politics never retreats. German flags are being burned in the streets of Greece, right-wing papers in the country compare Merkel to a Nazi while across the divide any remaining AAA country in the Euro are simply loosing interest in Greece who has proved a most unreliable partner in the battle for economic stability.

I’m no Keynesian but the repeated bouts of austerity demanded by Greece’s Euro creditors are pummelling the periphery’s economies harshly. I don’t believe I’ve ever heard a Monetarist or even an Austrian economist recommend pro-cyclical fiscal policy systemically. Austrians economists might say that recessions are good because they kill bad business models permitting the flowering of sustainable industry. However even the most die-hard fiscal hawks (me) have to admit that at an above 6% contraction yearly with no hope in sight for growth, even good businesses will flounder. That’s why fiscal consolidation in Greece needs to be accompanied by stimulus spending funded by the competitive parts of Europe. Pan-European unemployment insurance is the most sensible proposal that has not gone main stream yet. The moral hazard that will ensue is undeniable but until permanent mechanisms for intra-Euro fiscal transfers can be worked out, the benefits are surely worth the cost.

That said that the money masters’ responses to continued contraction in the periphery are inadequate, the reaction from the patients are increasingly unacceptable. In Italy the unions responses to the Monti plan for liberalization are tantamount to the summum of Human selfishness. While the house is burning the unions are trying to save their clothes while some are still trapped (the unemployed) admittedly while some have already fled (the tax evaders). The retired are equally deserving of blame silent on the whole affaire so long as their golden retirements are not threatened even when these same retirement plans are bankrupting their nation. But while Spain and Italy’s yields come down showing the markets forgiving side, or just the ECB vast manipulation skills, Greece and Portugal edge towards the brink. While tame in Lisbon, reactions in Athens are flaring up to an extreme.

I long ago learned that the most vociferous voices rarely represent or even understand the silent majority. The silent majority in most western countries are hard working middle class and relatively rational voters. Even when they are swindled into voting for a party that ill benefits their country’s these voters always (almost) correct their aim sending back their political systems to the center. This does not seem to be happening in Greece. Not only has the majority let its political leaders lead them to a path of reckless fiscal irresponsibility and stupidity, they now seem unwilling to admit to the wrongness of their ways. For God’s sake Greece’s politicians are asking to be the least trusted west of Tehran. Its anarchist youth are trying to give 80’s Italian terrorist youths a run for their money. To reverse an oft heard insult, the Greeks’ silent majority is about to be hoodwinked into poverty faster than Germans were into Nazism. Greeks have committed the cardinal sin of fiscal profligacy, they have been found guilty by the markets, they are now in a liquidity and solvency jail. The rest of Europe has posted bail, and now has promised to take Greece into a pseudo form of receivership in order to buy the fledging country a little decency and freedom. Greek response to the modest conditions demanded of it, spitting in the AAA’s faces. The audacity and hypocrisy demonstrated in the land of classical drama is baffling to say the least and shockingly amoral.

While I wish a speedy recovery for all of Europe and hope that the beauty of the European project can be furthered, I’d be lying if I didn’t say I believe the Greeks have lost all rights to participate in the next chapter of Europe’s history.

In praise of all that is German

Germany hasn’t been getting a lot of slack of late. Between accusations of trying to succeed where they’ve failed in two previous World Wars – dominating Europe – or accusations scuttling the European Project out of selfishness, and again with cries that Germany is abandoning the Euro, the nation of sauerkraut and beer is in the throws of a full blown Greek tragedy (lol pun intended). Asides from the on camera superficial Merkozy marriage, no french love seems to be crossing the Rhin. Further compounding the courteous hate fest, Italian flirting has gone from invitations to the bunga bunga parties (most often refused anyways) to the sober and stale Monti ear whispering for more cash. Somehow, I don’t think encouragements from the euro-sceptic nationalisty Finns was the recognition Berlin technocrats were looking for. The Euro area is eerily looking like an Animal Farm in the throes of its Orwellian infancy. Need I really specify which Euro countries are acting like over-eager egalitarian PIIGS, hrum I mean pigs, seeking the overthrow of opulent and oppressive markets, hrum… I meant masters. All punning aside, I believe there may be a little lack of balance in the debate over fiscal and monetary policy proposals to the Euro area mess.

Let’s start by awarding praise where it is due and sing the virtues of the German machine, hrum… economy sorry forgot about the inter-temporal analogy bank. To my knowledge German policymakers are the only ones of any major economy who seem to have learned the lessons of history. This is no coincidence as not-repeating the errors of history has become part of German culture. Little children are taught at school about the immeasurable harm generations of their ancestors have wrought upon the world (maybe even too zealously). A cursory look at the lessons young children learn from Dortmund to Munich, leaves the history amateur with a few residual lessons in economic virtue, that we shall survey here:

1) Inflation = bad. How so? Well inflation leads to economic inefficiencies most notable of which is the rise of unemployment, which then leads to socio-political problems we need not raise here. To see just how hawkish they are monetarily, read anything on the Bundesbank or even the ECB.

2) Trade competition = good (especially when your winning). How so? The best buffer when in hard times is to have a trade surplus and savings. Germany has been at the forefront of multilateral trade talks, especially in Europe (see European Union history) but also internationally. I guess Germans remember how bad Smoot-Hawley was for everyone and how good the life has been since… well… 1946 I guess.

3) Hard work = prerequisite to 2). Now I know this might sound sacrilegious to all of us westerners getting used to resting on the laurels of previous generations hard work but bear with me. Our current level of wealth is tied if anything to previous generations working hard, earning dough, not spending but saving dough in the bank account, that dough being magically transformed by the financial industry into fixed capital formation, a.k.a. every single piece of equipment, factory infrastructure that buttresses our current economies. If you didn’t follow the flow working harder than your living standard would entail serves as the anvil of tomorrows wealth. Germans get that, they preach it, than they actually do it. This saving/underspending/fixed capital forming needs to happen at the household level, the firm’s level and the governmental one.

4) Mash up all of the above = hawkishness in every sphere of public policy (and private actually) = kicking the worlds butt economically.

So what has been going on exactly in Europe? following the above stated framework for success lets see where things went wrong. Europe was a place of high savings (or at least American savings though the Marshall Plan)a, hard working and rebuilding for while following WWII. No problems so far. Italy, Britain and France had thriving industries, peripheral Europe slowly started democratizing itself. Than they started moving towards the European Union. Savings and investment flows started getting a little complex at this point. Big Euro countries started saving for peripheral ones, sending money so that those countries could invest in infrastructure modern

isation and other stuff of the like. Eventually thy took a bunch of countries with a myriad of fiscal and monetary systems and patched them together into a big currency block. Germany kinda knew where this was going so they tried the  true and tested policies. They retrenched further into fiscal and macro-prudential austerity. So yes this national savings craze as measured by a current account surplus peaking at 7.4% of GDP just before the crisis hit in 08, did lead to some imbalances within the Euro block by depressing Euro wide inflation numbers and interest rates. The real trouble however wasn’t German economic virtue it was the rest of Euro countries, more particularly the PIIGS, reaction to these circumstances. How did they react, like all good socialisty, humanisty, mushy hearted westerners, they indulged in profligate entitlement spending. Riding on the coattails of previous generations of hard work and contemporary German virtue (i know redundant), they offered their people an easy life at low borrowing costs.

Then one day the masters hrum… markets, sorry, woke up and said “the break is over back to work”. The current crisis boils down to looking to the Germans and saying no we don’t want to work as hard as you! keep paying. Unfortunately markets tend to act like the tough love parents that they are and Germany seems content to not act like the over-indulgent parent its savings temporarily were. Now some might quibble that the crisis is one of solvency or simply liquidity needing some temporary patching to be corrected. What needs correcting is peripheral Europeans expectation of living standards they must go down! if they are one day to go up to Germany’s level. Increasing the ESM or EFSF or introducing eurobonds does not solve the problem. Even Angela Merkel’s suggestion of limiting federal governments deficits to 0.5% of GDP remains to timide a goal. Mario Monti is somewhat on the right track in Italy. Although his reforms are limited in scale they are in the right direction. A combination of fiscal austerity coupled with market liberalization is the equivalent of putting italians back to work. Less play more labour! is the key to making labour unions howl and incidentally generating long-term wealth. Let’s hope more european nations decide to go the german path to prosperity before the s*** really hits the fan.

Cius