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Showing posts from 2011

Merry Christmas and a Happy New 2012!

The new 2012 bears a lot of questions on the eurozone, UK, US, China and so on, but lacks to provide many answers. Unemployment is still at high levels and is likely only to rise. Output on the other hand, as well as investments, are likely to fall. Stagnation is upon us. The reports of the most prominent world institutions predict this, but they also predict a bounce back in 2013. This is a bias their models hold, since no one takes into account the possible reactions if the euro falls, or if the Chinese bubble finally bursts. The picture is gloomy and the politicians are realizing this more quickly than before as their election dates are closer. The current situation of postponing the necessary solutions is only pilling up the pressure on them and is increasing the dissatisfaction and antagonism among voters. Sooner or later, we will all have to face the necessary consequences and accept painful solutions. Balanced budgets and increased bailout funds will result only in more debt ac…

The Great Mismatch between the labour market and universities

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The ever high unemployment levels worldwide and particularly the upsurge of youth unemployment is getting more and more people worrying. The hardship of finding a proper job for a recent graduate has become next to impossible in 45%-youth-unemployed Spain or 42%-youth-unemployed Greece. Other countries aren’t far behind. Europe’s youth is locked in an unemployment trap and some go so far to call it a ‘lost generation’. I refuse to be that pessimistic as the amount of brilliant young minds created is increasing with the technological development, student ‘migration’ and widening exposure to new ideas and ways of thinking. However, the fact that they remain unemployed stands and the solutions are lacking. Although I won’t go in much detail on how to fix youth unemployment here (as I see the problem of unemployment being solved through restoring confidence and removing uncertainty in the economy in order to increase private sector investment and eventually hiring) I will touch upon the m…

Graph of the week

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This week we take a look at an interesting figure showing the target levels of the new eurozone treaty (signed last week).

Source: The Economist, Daily chart

As the Economist says, "this time we really mean it!" The level of insubordination of the eurozone countries is astonishing. While some were balancing around the target in pre-crisis times, trying to cope with it, others were outright irresponsible, particularly right about after the credit squeeze in 2009, when the debt levels and the deficits soared. The debt levels are at an even worse state, knowing that the Maastricht target was 60% of GDP. How will the automatic punishments suppose to handle all of this and prevent further political mischief is still rather puzzling to me.

The path towards a fiscal union

One part of this post was published at the ASI blog, titled "Europe's road to serfdom"


The deal was struck. The EU and the eurozone are on a new path toward a more strict fiscal union. And with the deal, it is very likely a move towards a double speed Europe, or a union within a Union. Britain has isolated itself from the new treaty by a veto from its PM David Cameron. Whether such a move is good or not for the UK, only time will tell. It would be frivolous to make predictions now, as it is very likely that Britain will remain a part of the EU, only now left out of some main decision making and possibly regulatory standards. This isn’t necessarily bad, as Britain mostly suffered under various EU labour and financial market restrictions, but it is a question on how Britain might suffer politically. Loss of power and influence within the EU is certain, and it is left to see how this will impact Britain’s future motivation and public opinion regarding the EU. The break-up of…

Graph of the week

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Here's a figure depicting the history of eurozone sovereign bond spreads vs. 10-year German Bunds, from 1990 to 2011. 

Source: FT Alphaville, original source: Pictet
It is an interesting proof to the propositions madeherethat the introduction of the euro equalized the risks across eurozone which gave the peripheral countries an opportunity to borrow cheaply. This opened the scope for excess borrowing and fueling domestic growth with consumption and government expenditure. As an effect all the peripheral countries experienced severe current account deficits
What is interesting in the figure is how the spreads were much more volatile before the euro and the rapid decrease of volatility (and hence risk) once the euro was introduced. It appeared that every eurozone country could borrow as if it were Germany. It is obvious that this was fiscally unsustainable. The US spillover effect can be seen in 2008, but the credit squeeze that came about in 2009 fully uncovered the eurozone's i…

Never fear, the Supercommittee is here?

Did anyone really believe that after the August US credit rating downgrade caused by political quarrels, stubbornness and instinctive self-preservation, a committee made of an equal number of Democrats and Republicans would actually reach a favourable conclusion? I didn’t think so.
After all the pleas for the Supercommittee to go big and seize the chance to create an impact and make a credible reform, in more than three months work, last week they’ve announced the inevitable failure.
I admit, on first sight it seemed like a good idea. Any form of political indulgence of the deal was removed. The Senate couldn’t use its filibuster power, there was going to be no amendments in the Congress; it was supposed to be a simple yes or no policy effective immediately. However, then I remembered that the topic was the US deficit and the actors were US politicians, the same ones responsible for the US debt downgrade and market panic in August this year, and I quickly came to realize any hopes of …

Investment should be left to the private sector not the government

This blog post was also published at the Adam Smith Institute blog

Regarding the UK Chancellor’s last week’s autumn statement, if anyone had any doubts, one thing was made clear – the UK, much like the US, is embracing fully on a Keynesian path to recovery.  
The government took the plunge to direct private sector investment decisions. It is calling on pension funds to invest into infrastructure projects and even putting in some money by itself, it is calling on businesses to hire more young people (introducing an age boundary and a waiting list boundary) and offering them money to do so, it is calling on banks to lend more money to businesses by offering guarantees for these loans thereby setting a stage for another asset bubble, it is underwriting mortgages and driving the housing supply and finally it is doing all this in hope of satisfying narrow interests and in hope of ensuring political success.
The government is centrally planning the country’s development. And they are doing…

Graph of the week

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I will be introducing a new category on the blog, inspired by the economist's daily chart, I will randomly select and/or make interesting charts and comment them briefly. If it turns out to be popular, maybe I'll turn the category into 'graph of the day'. 
The first one is taken from the Economist's daily chart:
Source: The Economist, Nov 28th 2011.

It is the OECD GDP growth forecasts for the year(s) to come. It appears that 2012 will be the year of the double-dip recession. This will be particularly emphasized in case of a euro break-up. The European countries in the figure reflect this the most. On the other hand the US economy is expected to slightly increase growth to a steady 2%, while Japan is expected to rebound from its earthquake tragedy earlier this year. The developing economies will also be affected by the european slowdown as their exports are expected to fall.  It is worth noting that the OECD have made the predictions based on the fact that the current …

Subsidizing youth hiring is wasteful and will yield no positive long-term effects

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This post was also published on the Adam Smith Institute blog

The UK Chancellor George Osborne announced his Autumn Statement today, and here are some immediate UK think tank reactions. In summary, the Autumn Statement wasn't surprising; it seems that the taxpayers were bearing the burden of the crisis in order for the government to spend that money on wasteful infrastructural projects, mortgage guarantees (see here), loans to businesses (see credit easing) and essentially is trying to guide (dare I say centrally plan) investment incentives in the economy. 
Within the Autumn statement one proposal in particular caught attention, and it was a policy earlier announced by the LibDem Deputy PM Nick Clegg. The UK government wants to subsidize businesses in hiring young unemployed workers, precisely from the ages of 16 to 24, by offering £1bn to the private sector to take young workers into apprentice schemes. 
Under a typically political decision and explanation, youth unemployment i…

Long live the technocrats!?

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Plato would be proud. His idea that philosophers should govern is coming true in Italy and his very own Greece. Even though economists rather than philosophers are in power, economists are today most closely to being the ancient philosophers Plato had in mind. This isn’t at all a biased statement.
The idea itself has its benefits and its flaws. As a non-elected entity, how does this government serve the people? Is the very foundation of democracy at stake if we allow for legitimately elected governments to be replaced by parachuted technocrats? Even if the people have an utmost confidence in these new ‘rulers’ and consider them much more capable of handling the crisis situation, isn’t this necessary an attack on democracy and free choice of the voters? Not necessary.   
The technocratic governments were given legitimacy once approved by Italian and Greek parliaments. The elected members of parliament in both countries agreed upon that a new technocratic leader should step in instead of …

Reusing chewed-up ideas on the housing market

Note: this post was first published on the Adam Smith Institute blog, on Wednesday 23rd November 2011
On Monday, the UK Prime Minister David Cameron announced a new policy on housing designed to partially underwrite mortgage loans for first time buyers in order to make it easier for them to buy and own a house. The idea is to make new buyers provide only a 5% deposit for buying a new home, instead of up to 20% which the banks are demanding now. It is supposed to make the “ home-ownership dream” a reality for young people. The government and the construction firms will together underwrite a part of the loan creating an incentive to the banks to relax lending standards. This is aimed to help 100,000 new possible home-buyers who are excluded from the market due to high loan-to-value ratio’s.
The PM cleverly offered a caveat to potential critics by saying this policy won’t result in another asset bubble like it did in the US, since it is only focused on people buying new houses. It is sup…

Eurozone crisis – analysis of causes and consequences (part 4)

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The final part of the eurozone causes and consequences analysis deals with the outcomes of the sovereign debt crisis and how it now threatens to spread contagion back to the rest of Western world and undermine the current sluggish recovery. 
The summary and suggestions on the eurozone sovereign crisis and the critique of the policymakers responses were analyzed on this blog previously and can be found here and here
What were the outcomes?
Italian bond yields. Source: Bloomberg  In the last year every peripheral eurozone government was kicked out of office. Portugal and Ireland changed governments earlier in the year, Italy and Greece most recently got technocratic governments, while Spain held elections this Sunday and saw the victory of the conservatives announcing cuts and fiscal responsibility. The political implication of the crisis was huge, and naturally the politicians needed to pay the price. Governments such as Italy’s Silvio Berlusconi who managed to avoid being removed from o…

Eurozone crisis - Intermezzo (2)

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Just a quick look at the daily chart from the Economist.




























Source: The Economist, 22nd November 2011

Observe the obvious differences between the North (Gernmany, France, Netherlands, Belgium, Austria, Ireland) and the South (Greece, Italy, Portugal, Spain) in the eurozone. The set of graphs itself don't necessarily prove any causal relationship (that geography or a relaxed southern lifestyle has something to do with it for example), but they can provide an interesting comparison. They can also provide support for the claim on too large differences between these countries to have a single currency, or the net borrowing effect on the international markets that led to high current account deficits of the 'South'.
The graphs can make an inference on one thing emphasised in the last three posts on the eurozone debt crisis - a welfare state used to fund populist policies cannot lead to a sustainable growth path, only a temporary boom; it will result in increasing existing domestic i…

Eurozone crisis – analysis of causes and consequences (part 3)

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After the initial identification of the causes of eurozone contagion in domestic and foreigninstabilities, having in mind the current debt situation we now look at how and why the banks got incorporated into the peripheral contagion, which led to further systemic risk, and finally, how did the collapse take place after a sudden credit stop.
How the banks got caught up buying peripheral debt?
As was already noted in this blog, eurozone banks were buying the peripheral debt as part of their zero risk-weighted assets. While the regulatory requirement on holding a corporate loan was 8%, the capital requirement for holding sovereign debt was just 1,6% (sovereign debt, considered to be a zero risk asset was given a 20% risk-weight, resulting in the total 1,6% of capital requirement for sovereign bond holdings). This meant that if a bank was to lend to sovereigns instead of businesses it could make much more money (leverage on sovereign bonds was 62.5 to one compared to leverage on business lo…

Eurozone crisis - Intermezzo

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Here's something to keep it interesting while waiting for the next few posts on consequences and the remedies of the eurozone crisis. 
I 'borrow' this figure from the Economist, depicting debt burdens of eurozone economies:

Source: The Economist

The graph serves as a good reminder on importance of debt levels and the sustainability of these debt levels on investor confidence and country bond yields. Greece, Italy, Portugal and Ireland (4 out of 5 countries analyzed previously) are countries with the highest debt burdens in the eurozone and are the countries most exposed to the threat of default. 
In addition to this I would like to stress out the mechanism of outside contagion described excelently by Reinhart and Rogoff (2009) (I summarize their main findings on the spread of contagion throughout the world financial system):
"Banking crises in advanced economies decrease growth of these economies. This slowing of growth and economic activity will hit exports thus eliminat…

Eurozone crisis – analysis of causes and consequences (part 2)

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The second part observes problems inflicted to the eurozone economies from abroad. It then looks at how foreign capital inflows (due to large CA deficits shown in part 1) were used in domestic economies. 
(Regarding the current affairs, the economist offers its own short history of the eurozone crisis, worth reading. In addition, its Free Exchange blog offers two good texts on the current eurozone affairs, one on Spain, the other on Italy. Tyler Cowen offers an interesting summary on what we learned from the euro crisis on his blog Marginal Revolution.)

Instabilities from abroad
Problems with a CA deficit and the common currency
When one country runs a current account deficit, this implies that it runs a surplus in its capital account. A capital account surplus means an inflow of foreign capital (investments) into a country, which is essentially a good thing since money will always flow to where it expects the highest and safest returns. However, the question is where is the money from ab…