Friday, 28 February 2014

Where goes?

Where goes Ukraine?

That's the question on everybody's mind.

With the ousting of Yunokovich, who in the face of clear evidence of rampant corruption was abandoned even by his own party in parliament, will Ukraine resume its road for gradual integration within the EU, starting with an Association Agreement,   or will it have to balance its internal dissent of the pro-Russian Eastern part of the country by maintaining the status quo?

It is highly optimistic to assume that Putin's Russia will permit to have an important strategic border with a country that professes an EU integration vocation.  Russia can easily create a pretext for occupation of Crimea and Eastern Ukraine to defend the interest of ethnic Russian majority in the region.  Putin is unlikely to allow a Russia without buffer zones between it and western countries.

So I am afraid that for the short term Ukraine's future seems tumultuous and its territorial integrity could be prejudiced.   For the longer term I view this development more positively.  Even Germany after WWII did not remain divided for ever.   So even a divided Ukraine could be a transit situation to a more stable post Putin Russia where economic realism will force its leaders to admit that Russia can no longer pretend to a be a stand alone superpower.

Russia's economy remains unsustainably dependent on energy.   Internal corruption and repression will force change upon Russia  who in the end will be forced to seek active participation within a more flexible EU to permit different levels of political and economic membership underpinned by a free trade area.

As China grows into the second element of a bi-polar world Russia can only remain relevant if it joins the movement for European integration to ensure that Europe remains geo-politically relevant and not merely a sandwich filling between the US and China.

How long is long term?   That's anybody's guess but these things take time.   Germany's division lasted 45 years but then it happened overnight.  Pressure builds up very slowly but when the tipping point is reached the change will be sudden and total.

Where goes Ukraine? Unavoidably it has reached the point of no return where it has to go west even if it risks losing control over parts of its eastern territory for some time.   Where goes Russia?   For some time Russia will continue to play let's pretend we are still a superpower macho game.  Unavoidably for the longer term Russia goes where Ukraine goes; west.

My thoughts and prayers are with Ukraine with the hope that the transition will be short, not too painful and bloodless.

Where goes the Euro?

At a time when periphery Euro Area needs a lower Euro against the USD and the Yen ( to enhance their export competitiveness) , it is quite perplexing that the Euro continues to stay strong.   What underpins the Euro is the fact that as a whole the Euro area runs a balance of payments surplus, so on average it is competitive and can live with current level of Euro forex (f/x) value.   But averages are as deceptive as having an average correct body temperature with the head in the oven and feet in deep freeze.

The balance of payments reason cannot explain it all.   F/X values are not just influenced by balance of payments issues but mostly by capital flows.   Capital flows are influenced by interest rate movements.   So at a time when interest rates in US are expected to follow an upward trajectory whereas in the Euro area the ECB is considering entering uncharted territory through negative interest rates, the strength of the Euro is hard to explain.

My guess is that the Euro is suffering competitive beggar thy neighbour devaluations of competitor currencies who are more organised to manage the level of their currency with a single Treasury, whereas the Euro has 18 Treasuries.

The Euro is suffering the consequences of its conservative wisdom whilst many around it are going mad with competitive devaluations which are causing great problems to emerging markets ( Brazil, Turkey, India, Thailand and China)  who are also forced to join the currency warfare.

In the end wisdom will be rewarded but as Keynes once said, in the long term we are all dead.

Wednesday, 26 February 2014

Getting the true picture of unemployment

Are you fed up of the endless arguments between Government and Opposition where the former emphasises that the employment situation is getting better whereas the latter stresses that the unemployment situation is getting worse?

In theory, because of the old adage of lies, damn lies and statistics, both arguments could be correct.   If the labour supply increases more than employment, government could boast of increased employment and the opposition could point out increased unemployment.

To avoid this statistical conundrum one has to avoid going by registered employed or unemployed and read the situation through the Labour Force Survey which rides over the erratic registration issues and looks at employment and unemployment in toto, irrespective of whether registered or not.

To give an idea about the difference in results produced by different methodologies just see these figures both related to September 2013:

                                     Labour Force Survey Q3/2103     Registered Statistics September 2013

Employed                                        179476                                          157684
Unemployed                                      12827                                              7619

Labour Supply                                 192303                                          165303

What this basically means is that over and above registered workers there additonally are some 21792 productively employed, but unregistered and therefore paying no payroll taxes or national insurance.    It means there are a net additonal  5208 unemployed persons  who wish to work but are not registering with the ETC.   It also means that our labour supply is 27000 (16%) greater than official registered records indicate it is.

So politicians of left or right should stop singing from the hymn book that suits them, which gives a very incomplete picture of the employment situation, and instead interpret employment data from the Labour Force Survey (LFS)which is more complete and consistent.

The last LFS is for Q3/2013 and in comparison to Q3/2012 the situation is :

                                                                     LFS Q3/2103            LFS Q3/2012

Employed                                                          179476                    174126
Unemployed                                                        12827                      12283

Labour Supply                                                   192303                   186409

This shows that unemployment has held steady in absolute terms even though the Labour Force increased by 5894.   In percentage terms the unemployment as a percentage of the labour force kept steady from 6.59% to 6.67%.

In September 2013 the present government had been in office for just 6 months.   It is doubtful whether in the first 6 months any government can do anything material that translates into noticeable differences in the rates of employment / unemployment, although the very removal of uncertainty of  elections help to stimulate job producing investments.  In fact jobs increased in the 12 months to September 2013 by 5350 compared to 3660 in the previous 12 months.

It is too early for the government to take credit for job creation as well as for the opposition to pin fault on government for what they perceive as rising registered unemployment.   Generally such increase in registered unemployment in the context of increasing employment is sign of people who had stopped registering coming back on the labour market as they perceive better employment prospects.

But for the real analysis of government labour policy effectiveness we have to await a few more LFS quarterlies.

Monday, 24 February 2014

Men in a hurry

This article was published in The Malta Independent on Sunday - 23 02 2014

It is easy to label Matteo Renzi as a man in a hurry. He has brought new energy and determination to the Italian political scene. Italy desperately needs a true leader with a sense of urgency and many consider Renzi as Italy’s last hope.

Italy would have had a stable government if, before the last elections this time last year, the PD had chosen Renzi as its leader rather than old-school Bersani who managed the impossible, wasting a substantial poll lead, and practically single-handedly losing the election of February 2013. This condemned Italy to an unstable government under fellow PD Enrico Letta who had to organise a gruelling grand coalition with Berlusconi’s party (before the latter split up).

Politically, it would have suited Renzi to allow Letta to stay in position for a few more months to continue cleaning up Italy’s fiscal mess and until a new electoral law was in place to ensure that the electoral process could deliver a clear winner capable of forming a stable government.

But for someone in a hurry, Letta works too slowly, makes too many compromises and shows insufficient urgency for getting things done. Bubbling to show that he can do for the country what he has done in Florence; that he can modernise the country and liberate it from the clutches of lobbies and vested interests; Renzi took the plunge and pushed Letta aside positioning himself to become Italy’s youngest ever Prime Minister. Political programmes that normally translate into action plans spanning years, which never get done as Italians governments rarely survive that long, Renzi has to execute in terms of months.

Renzi is business friendly but unashamedly left opinionated. He knows that national interest cannot afford the distraction of early elections. National interest demands focus on efforts to regain competiveness. Italy needs to compensate the time lost as a result of politicians’ in-fighting that compromised the national interest to serve their own constituency.

In many ways he is a replica of our Prime Minister Joseph Muscat. He is even younger and more ambitious, and Renzi has a harder task as he does not have the comfort of a solid parliamentary majority that Dr Muscat enjoys.

But in forcing himself to become the third Italian Prime Minister in a row without commanding a direct electoral mandate, Renzi is taking a grave risk.

Unless he manages to deliver within months where others have failed for years, he could dent the aura which currently depicts him as the man that can save Italy and risks becoming a historical footnote in the long list of Italy’s post-war unstable governments.

He has a tall order: changing the electoral law, changing institutions, including the abolishment of the Upper Senate, reducing cost of doing politics by eliminating layers of regional and local government, restructuring the judicial system, reducing the cost of employment and above all infusing fresh confidence to attract new investments that create jobs and stimulate economic growth.
Being in hurry could be a virtue as much as a vice. Renzi must make it a virtue, for Italy and for Europe. Europe cannot be a stable place if Italy stays fickle. Renzi is Europe’s best hope to help smooth out the difference between core and periphery EU.

Renzi cannot do it on his own. He needs particularly the help of another Italian in Frankfurt, Mario Draghi, the President of the European Central Bank (ECB), the only supra national European organisation that can operate in the name of the whole euro area without needing approval from national parliaments.

Renzi needs Draghi to maintain his ‘whatever it takes’ pledge to keep the cost of borrowing for Italy’s sovereign debt low and close to Germany’s, the best in the class. He needs Draghi to use his soft but effective power to get Italian banks recapitalised and healthy so that they can resume operating as normal banks extending credit to SMEs and small industries that create jobs and generate growth. The absence of such effective credit mechanism is forcing many Italian industries, even those with export potential, to give up and close doors. Only this week, Italian industrialists felt the need to protest on the streets, an experience normally reserved for trade unions. But with unemployment as high as it is, labour seems to have lost even the spirit of protesting.

Renzi deserves European support and hopefully Germany can understand that he represents the best hope for the EU to find its path back to an ‘ever closer Europe’ in the context of economic growth and social solidarity.

I hate crossing swords with Mr Anthony R. Curmi, a formidable and independent defender of the interests of former shareholders of the National Bank of Malta. I hate it, as Mr Curmi is a fine gentleman and I owe him a lot for my career as in the early years he was my boss and my mentor at Barclays/ Mid-Med Bank.

In essence, there is one point of disagreement between us. While Mr Curmi promotes an out of court settlement (Compensation for ex-National Bank of Malta shareholders, TMIS, 16 February 2014), I maintain that at this late stage justice can only be served if based on a court judgement. The argument that this will take long to come no longer holds. Recently, the Judge delivered a preliminary sentence in three court cases and one expects that the same Judge will now deliver judgement to quantify the compensation due. Having come to this stage we don’t need another one in a hurry.

Any consideration for an out of court settlement has at least to await the award of compensation by the first court and then the parties will have to decide whether it is in their interest to negotiate or to appeal.

I think this chronological order of doing things is important because when it comes to quantification of compensation, the judgements, all by the same Judge, send what prima facie seems conflicting messages.

In one sentence (Court case 282/1977/2), the Judge says:

“The bank’s administration at the time declared that the shares had lost all their value. They said this to the shareholders and repeated same in court under oath. They said as much after consulting the best legal minds and in full knowledge that the bank had assets and in spite of having huge reservations on the way government treated them in those crucial hours. It must be stated that it was the bank’s own administration that started procedures for court approval for shares of particular shareholders to be transferred to government without compensation. The Court holds no doubt that these declarations were not made lightly, or with ulterior motives or to gain time but were declarations made on the basis of the critical situation of the bank that was not in a position to continue operations in those conditions at the edge of insolvency, or at least, in the state of illiquidity that it found itself in.
“The declaration that the shares had no value was one of the reasons why the Civil Court Second Hall authorised transfer without compensation to government of shares in name persons who had no civil capacity to act without court protection and safeguards. In other words, the decision by that court was a judicial pronouncement of the situation as it was at that point in time and not an impression that was formed much later.”

Yet in the other two sentences, the same judge states:

“Although it is true that at the time the shares no longer had a negotiable value because of the state of illiquidity of the bank, there is no doubt that the bank had substantial assets that exceeded the liabilities that may have existed. This was (net) value that was worth and proved its worth in the administration of successor organisations to the bank’s business. It was value that left the hands of the shareholders and for which they received no compensation.

In defining the compensation, the Judge will have to give a meaning to these conflicting opinions. Basically, these questions have to be answered:
  1. Can the court depart from the normal commercial practice of value being established at the point of the transfer irrespective of what happens after? 

  2. Whereas in the first quoted extract the Court acknowledges that the bank may have been on the verge of insolvency, in the second quotation it speaks merely of illiquidity. Does the Court appreciate the difference between a state of illiquidity and insolvency?

  3. The difference between insolvency and illiquidity should have a great bearing on establishment of compensation due. If the bank was insolvent, the bank could not have been saved without fresh capital and as no one was prepared to put up fresh capital other than the government, then the government had the right to set its terms that the shares were valueless. If the bank was merely illiquid no fresh share capital was necessary and the Central Bank could have saved the day by operating its lender of last resort function.

  4. Is the court prepared to usurp and overrule the role of the Central Bank in determining that in the circumstances then prevailing that the bank was insolvent not merely illiquid, so much so that it was not supported with lender of last resort liquidity?
I await the full court decision before making final analysis of its fairness and suitability.

Thursday, 13 February 2014

Two Italians: one in a hurry - one biding time

The future of the EU may depend on two Italian gentlemen.

The Italian in a hurry

It is easy to label the new head of the Italian left of centre Partito Democratico (PD) and Mayor of Florence, Matteo Renzi as a man in a hurry. Renzi has brought new energy and determination to the Italian political scene.

Italy would have had a stable government had the PD chosen Renzi as its leader rather than old-school Bersani who managed the impossible wasting a substantial poll lead and practically single-handedly lose the election of February 2013.  This condemned Italy to an unstable government under fellow PD Enrico Letta who had to organise a grand coalition with Berlusconi's Party before the latter was split up.

Politically it would suit Renzi to allow Letta to stay in position for a few more months until he takes the hard decisions necessary to continue cleaning up Italy's fiscal mess and until a new electoral law is in place to ensure that the electoral process can deliver a clear winner that can form a stable government.

But Renzi is a man in a hurry.  For him Letta works too slowly, makes too many compromises and shows no urgency to gets things done.   Renzi is bubbling to show that he can do for the country what he has done in Florence; that the same way he worked his way to become the uncontested leader of the PD he can prove to be the man that Italy needs to modernise the country and liberate it from the clutch of the various lobbies and vested interests.

Renzi is business friendly but unashamedly left opinionated and he makes no secret of his ambition to win an outright mandate without having to borrow support from other political philosophies that dominate right wing parties.

In many ways he is a replica of our Prime Minister Joseph Muscat.

But in forcing himself to become the third Italian Prime Minister in a row without commanding an electoral mandate, Renzi is taking a grave risk.   Unless he manages to clear up the moderate agenda of this government, especially the change in electoral law, and take the country to fresh elections rather quickly, he risks denting the aura which currently depicts him as the man that can save Italy.

Being in  hurry could be a virtue as much as a vice.    Renzi must ensure that he turns it to a virtue a he is Italy's real and only hope.   And as Europe cannot really be a stable place if Italy stays fickle, Renzi is also Europe's hope to help smooth out the difference between core and periphery EU.

The Italian biding his time

If anyone deserves merit for calming down the Euro crisis and restoring confidence in the capital markets thus permitting peripheral countries to borrow on the market at sustainable interest rates than that person is Mario Draghi, the President of the ECB, an Italian biding his time.

The ECB is the only supra national European organisation that can operate in the name of the whole Euro area without needing approval from national parliaments.

Because it can do so, the limits of authority of the ECB are circumscribed by its constitution, rendering it responsible only for price stability through the operation of monetary policy.   The ECB is not responsible, like other Central Banks, for low unemployment, economic growth, balance of payments stability and other macro-economic issues.

This puts the ECB in a very serious dilemma.   How possible is it to have proper tools for execution and transmission of monetary policy if it does not also have control over other macro-economic policy issues?

EU politicians realising their inability to forge ' an ever closer Europe' beyond what is possible on the basis of the present EU institutional arrangements, by default rely on the ECB to keep things together when they are unable to.

So when the Euro area was on the verge of disintegration in July of 2012 it was Mario Draghi with the famous 'whatever it takes' statements that calmed the markets.   Later on he defined the 'whatever it takes' by announcing the Outright Monetary Transactions programme (OMT) for countries that need ECB support but only if they engage to a macro-restructuring programme with the ESM.

Now the ECB has been commissioned to act as the single supervisor for large banks in the EU with authority to operate or influence a common resolution mechanism for banks that are destabilising and causing systemic risks.

Draghi is biding his time.   The ECB is performing a deep analysis to check the health of the banking institutions it is meant to supervise before taking over responsibility therefor.   There is a grave risk that such deep analysis will expose capital deficiency which has somehow to be financed.   Politicians are unduly optimistic to assume that such an occurrence can be handled without destabilising the markets, as the risk of bail-ins and bail-outs becomes more real.

At some point in time Draghi will force the EU politicians to decide whether they want to risk such destabilisation or whether they want to authorise the ECB to interpret its mandate as permitting some sort of monetisation of the ESM so that the capital deficiency would be filled without undue macro-instability.

Draghi not only plays his cards well, but he plays them at the right time.  For time being he is biding his time.

Monday, 10 February 2014

Generational betrayal

This article was piublished in The Malta Independent on Sunday 09 02 2014

Every time I deposit my pension into my bank account, I get mixed feelings.

Graduates celebrate during commencement at Yale University in New Haven, Conn., Monday, May 23, 2011.  (AP Photo/Jessica Hill)
US graduates celebrate before
being crushed by loan repayments.
Malta education system is social
and sensible avoiding the worst forms
 of generaltional betrayal.
On the one hand, I have worked for nearly 45 years and have contributed substantially to the national coffers through direct taxation, national insurance contributions and indirect consumption taxes. So part of me feels a certain degree of entitlement to the pension.

On the other hand, I feel that I form part of a generational betrayal, which the democratic force in numbers of the baby boomers generation is imposing on its successors. Let me explain.

As those born between 1945 and 1965 – the decades following the end of World War II – reach pensionable age, the unfunded pension systems of most European states, including Malta, will feel the stress of a larger number of claimants and a reduction in the number of contributors. The ratio of pensioners to economically active contributors will fall, thereby making it difficult for subsequent generations to keep the system sustainable.

The baby boomer generation has been extremely lucky. We have lived through a period of peace and unprecedented economic development, during which the standard of living has increased beyond anyhting previous generations could only have hoped to aspire. Now, the baby boomer generation feels entitled to retire and draw on social security and public health service benefits for a period much longer than any actuary could have imagined when the contributory systems to such entitlement schemes were initially designed.

This is leaving a legacy of huge public debts and enormous future obligations to subsequent generations. It is the result of short-term economic management, where development was based on consumption rather than investment and on credit rather than on savings, leading the baby boomer generation to benefit from higher entitlements and lower taxes; even during their economically active life.

Furthermore, baby boomers benefited from rising asset prices. The homes they bought with pennies are now worth tens of thousands. Their savings in financial assets have also grown, provided they were carefully managed.

The younger generations must now contend with our legacy: a rising deficit that cannot even be reduced through privatisation revenues, as whatever could be has already been privatised. So the younger generation face the prospect of higher taxes to keep the deficit from exploding beyond the point of no return (somewhere between 90 and 100 per cent of GDP for most economies) and has to suffer austerity measures, including reduced entitlement benefits coupled with the need to show more flexibility in their work practices to bolster productivity.

I therefore feel somewhat ashamed that my baby boomer generation – unlike our predecessors who made great sacrifices, having experienced two world wars in the first half of the 20th century – is not leaving a better world for our successors.

Faced with a dire situation caused by the betrayal of the baby boomer generation, maybe it is worth considering that part of the re-balancing ought to be made through the toleration of higher inflation. A few years of inflation at four per cent would be very effective in transferring wealth from the retiring baby boomer generation (who normally have interest-bearing financial assets and no debts) to the economically active younger generation (who normally have real assets bought at high prices and financial debts). Maybe it is the only way by which to lighten the debt-burden being imposed on future generations and to avoid a general depression where everyone would be a loser.

Yet, at least in the EU, we seem to be heading in the opposite direction, as inflation falls dangerously below the two per cent target and approaches zero, where disinflation will turn into deflation, where the general level of prices not only rises more slowly but does not rise at all with the risk that if prices start falling, the economy will be trapped in a negative spiral as consumption is deferred once people perceive they can buy cheaper tomorrow.

Some eurozone countries are dangerously close to such a situation and the assurance given by the ECB this week that it does not see a risk of deflation seems optimistic. Without the wheels of credit creation working efficiently, there can be no sustainable economic growth and monetary policy will remain sterile as the channels for transmission of the interest rate policy will remain blocked. Without banks operating smoothly to deliver credit to SMEs who create jobs, economic growth will remain anaemic. Even if deflation is avoided, real recovery will take unduly long and unemployment will remain a chronic problem.

Banks must be recapitalised so that they stop acting like zombies and start acting as real banks, seeking to lend money profitably rather than being obsessed with how to reduce their balance sheets. In many EU countries, investors are not prepared to put new money in bank capital. They have been burnt these last few years with harrowing equity losses and do not see a clear indication of how any new investment in bank capital will be sufficiently profitable. Countries are indebted up to their ears and can hardly be expected to borrow more to fund bank recapitalisation. The ESM mechanisms to recapitalise banks are subject to strict conditions, making it practically impossible to access.

Yet the ECB is proceeding with an Asset Quality Review (AQR) of the main European banks which, if done rigorously (as otherwise there is no purpose of doing it in the first place) could expose gaping holes in banks’ capital requirements without having a ready source to address such capital deficit. All the pieces are in place to create a dangerous destabilisation of the EU banking markets.

One hopes that, as we get nearer to the results of the AQR, politicians will become more sensitive to these risks and will simplify the procedure whereby the ESM can use its resources to recapitalise banks that are under-capitalised but not insolvent.

And if this process has to involve some European version of quantitative easing or monetisation whereby the ECB, through its monetary policy can do what the EU as a group and many countries as separate countries are unable to do through fiscal policy, then so be it.

The typical German argument against such monetisation is that it could let the inflation genie out of the bottle. But the current problem is the opposite. It is disinflation not inflation. Even if such looser monetary accommodation were to reverse the current dangerous trend and deliver inflation somewhat above two per cent, it would not be the end of the world. As former governor of the Bank of England Mervyn King said, traditional monetary policy alone cannot right all that is wrong in the economy and circumstances may arise where monetary policy will, for the common good, have to tolerate somewhat higher levels of inflation. It is simply the choice of the lesser evil if the alternative is an endless recession.

Somewhat higher levels of inflation could also put right the generational betrayal where, for the first time, many EU countries see the prospects of the upcoming generation being less well off than their parents.