Did You Know?

Did you know that Ireland and Spain were once rated AAA? For Ireland, Oct 2001 to March 2009; and for Spain, Dec 2004 to Jan 2009.

Did you know that Greece was at one time rated A+? June 2003 to Nov 2004.

Did you know that the average credit quality across the GIIPS is currently BB+? According to S&P rating definitions, that’s below investment grade quality (so-called junk).

Even without Greece, did you know that the average credit quality of the IIPs is BBB- and borders junk status?

Did you know that S&P never downgraded all 5 PIIGS credits in one month? In January 2012, S&P downgraded Italy, Portugal, and Spain by 2 notches each to BBB+, BB, and A, respectively.

Did you know that S&P downgraded Greece to SD, or selective default, for 3 months in Feb 2012? Greece is currently CCC and was upgraded from SD in May 2012.

Rebecca Wilder

Note: The rating data are from Bloomberg.

Her points are well taken. I look at this draft proposal and wonder how can they credibly attack any of these issues in detail at the 18-19 October Summit. I digress and expand on Megan’s statement:

The German government has signaled support for rerouting taxes (including corporate and value added tax) to Brussels. How will the German (and Dutch, Austrian, and Finnish) electorate feel about this when they are paying higher taxes that are then redistributed not only to basket cases like Greece but also to Ireland, which benefits hugely from a low corporate tax rate?

There are two additional points worth noting. First, of the 15-odd euro area countries that are listed in the OECD tax database, Ireland has the lowest corporate tax rate in 2012. However, as regards the 2011 cross-country VAT tax rates, the Irish rate ranks the 5th highest.

Exhibit 1: 2012 Corporate Income Tax Rates

Exhibit 2: 2011 VAT Rates

Normalizing taxes across national borders will be a difficult task. One would need to establish a ‘federal rate’, thereby allowing the 17 municipalities (countries) flexibility to set their own policies but with bound budgets (i.e., no support for local, or municipal budgets).

This brings me to my next point. To my knowledge, it’s not clear whether Rompuy is proposing a pan-euro taxing authority or simply subsidizing the budget with national contributions. This makes a difference. A pan-euro taxing structure would be much more opaque, whereas national contributions would be more widely televised. I suspect that the issue of redistribution of tax payments from core to periphery economies (see Megan’s point above) would be less meaningful if the budget was funded via a federal tax net rather than national contributions.

Have a wonderful weekend! Rebecca Wilder

Since the  outset of the ECB’s most recent rate-cutting cycle -  here I’m referring to recent cuts that occurred after the ECB mistakenly hiked its policy rate in July 2011 – mortgage and non-financial corporate lending rates declined across the euro area except in Italy.

Change in mortgage rates

Change in corporate lending rates

Italy is the one country with a clearly ‘hampered’ transmission channel, as mortgage rates and non-financial corporate lending rates rose 0.51% and 0.36%, respectively, despite the ECB cutting its policy rate. Portugal and Spain did see lending rates fall, but to varying degrees.

Since the month of July – July 26 was the date that Draghi promised markets that “the ECB is ready to do whatever it takes to preserve the euro” – rates in Spain and Portugal declined in line with the core. In the case of non-financial corporate lending rates, the average periphery rate declined  0.46% more than the average core rate.

Change in mortgage rates since June 2012:

Average Core *: -0.13%
Average Periphery *: -0.16%

Change in non-financial corporate lending rates June 2012:

Average Core: -0.11%
Average Periphery: -0.57%

Recently, it’s evident that financial conditions via mortgage and non-financial corporate lending rates are improving in the periphery.

Mortgage rates trending down

Non-financial corporate lending rates trending down

On balance, the trend is positive. Notably, too, the Spanish corporate lending rate remained roughly unchanged in the month of August. This is a positive development, given the 1.4% drop in those rates in July.

Rebecca Wilder

* Core = Austria, Belgium, Germany, Finland, France, Netherlands
* Periphery = Greece, Ireland, Italy, Spain

This discussion reminded me of an article that Randy Wray (Professor of Economics at UMKC, blogger here at Economonitor  and New Economic Perspectives) wrote two years ago: The Federal Budget Is Not Like a Household Budget: Here’s Why. The following is an excerpt from the article but the whole thing is worth a read:

4. The federal government is the issuer of our currency. Its IOUs are always accepted in payment. Government actually spends by crediting bank deposits (and credits the reserves of those banks); if you don’t want a bank deposit, government will give you cash; if you don’t want cash it will give you a treasury bond. People will work, sell, panhandle, lie, cheat, steal, and even kill to obtain the government’s dollars. I wish my IOUs were so desirable. I don’t know any household that is able to spend by crediting bank deposits and reserves, or by issuing currency. OK, some counterfeiters try, but they go to jail.

Rebecca Wilder

Coming to the answer of this question can be rather complicated.

According to the Federal Reserve’s latest flow of funds accounts (see Table D.3 in the following .pdf link), federal debt outstanding was $11.11 trillion. US household debt and US non-financial business debt outstanding were each greater: $12.95 and $12.01 trillion, respectively. Here, the US federal government does not have the largest stock of debt outstanding.

Well, you may then say the following: look at the general government, or the public sector which includes the US federal government plus state and local governments. The public sector (general government) does have the largest stock of debt outstanding, $ 14.11 trillion. But for a comparable analysis, then one needs to consider the ‘private sector’, which includes household plus non-financial business debt outstanding. Private debt outstanding dwarfs that of the public sector debt outstanding: $24.95 trillion vs. $14.11 trillion, respectively.

While the US federal government is popularized as being the largest debtor in the US economy, it’s not. Look at the time series in natural logs – by taking the natural logarithm of the public and private debt outstanding series, the slope of the line is a growth rate. I’ve put the two on different axis, so this chart is not precisely correct; but the trajectory of government debt took another leg upward on Q1 2008 at the outset of private sector deleveraging. Better put: the government is ‘financing’ the private sector’s desire to save.

So outside of default or inflation, the government does bear the ultimate burden of private sector debt.

Clearly there are legacy issues with the federal government debt overhang – wars, wealth taxing policies, etc. But the entire story of debt burden includes a large share felt by the private sector; this often goes unnoticed when bringing up ‘debt’.

Another part of the story for the US federal government that is bound to come up in a discussion of public debt is the GSEs and contingent mortgage liabilities for the government. The government’s responsible, either explicitly or implicitly, for about $5 trillion of mortgages outstanding - this is not included under the ‘federal government’ debt outstanding above. To that I would reference the $16.1 trillion in financial debt outstanding (domestic financial plus foreign debt outstanding in Table D.3), of which GSE-backed mortgage pools are a function. There’s still quite a bit of financial leverage in the private sector. In the 1980s, the stock of financial debt outstanding was 22.1% of the total non-financial debt outstanding. Today, financial debt is 41.3% of total non-financial debt, and that’s down from a peak of 56.7% in Q2 2008.

Debt is a complicated story. What’s less complicated is that there’s too much of it.

Rebecca Wilder

The chart below illustrates the level of the unemployment rate and its month-month change for the euro area 12 countries.

The periphery are underperforming the average, with Spain, Greece, Portugal, and Ireland leading the way. Internal devaluation, or driving up the unemployment rate to reduce relative prices with demand, is really taking its toll. Respectively, the unemployment rates in Spain, Greece, Portugal, and Ireland are 178.9 ppt, 234.2 ppt, 93.9 ppt, and 212.5 ppt above their pre-crisis minimums (loosely defined since January 2008) – a simple average of 179.9 ppt above the joint minimum for these four countries. The average euro area 17 unemployment rate is just 56.2 ppt above its 7.3% pre-crisis minimum. Hard days in the periphery, to be sure. Against this backdrop, weekend protests in Paris, Madrid, Lisbon, and Rome are not a surprise.

I further point out the troubling trend in the French labor market, as the new government presents its fresh austerity budget for 2013.

This budget is highly dependent on tax revenue and positive growth momentum, which is likely to disappoint amid such deterioration in domestic demand. See Ambrose Evans-Pritchard on the expected budget impact.

As opposed to the FT, though, I would argue that the transmission mechanism is at least not getting worse in Spain and Portugal, and worsening in Italy. Italy is the only periphery economy (where data is made available) where the corporate borrowing costs are higher since the peak of corporate lending rates in the Euro area in July 2011.

The FT is wrong. It takes Spain as the case study and uses the incorrect corporate lending rate information. Specifically, according to the FT (bolded by RW):

The interest rate charged by banks on a corporate loan of up to €1m lasting between one and five years – which would typically be taken out by a small business – was 6.5 per cent in July in Spain, according to the ECB figures.

True, the rate on new business loans up to and including €1 mn with maturity of 1-5 years did see an average borrowing rate of 6.5% in July. However, corporate loans up to and including €1 mn with maturity of greater than 5 years saw a drop in borrowing costs of 1.4% in July to 5.17% . The 5.17% rate is the rate that should be quoted, rather than the 6.5% rate.

The 2012 Euro area stock of outstanding debt shows clearly that 57% of corporate loans had been made with maturity of greater than 5 years – the ECB provides no breakdown of loan data by maturity at the country level, so the FT must have been referring to the ECB’s Euro area data as the ‘typical loan’.

As demonstrated in the chart below, the story is much more complicated than the FT curtly portrays – it’s not just ‘Spain’ versus ‘Germany’. French corporate borrowing costs barely budged since July 2011. Furthermore, the corporate borrowing rates in Spain are improving rather materially compared to those in Italy and Portugal.

Italian corporate borrowing are up 0.67% since the peak of EA corporate lending rates in July 2011 (the ECB hiked its policy rate on July 13). Spanish corporates, on the other hand, saw corporate borrowing costs fall the most of all the periphery economies, -1.35% since July 2011.

As demonstrated in the illustration below, the core is benefiting largely from ECB rate cuts compared to the periphery (chart 1 below). However, on a 3-month moving average (the rates moves are pretty choppy in Spain), the transmission mechanism in Spain is improving relative to that Italy and Portugal (chart 2 below). Using the correct data, the FT should have included this information in their article.

Rebecca Wilder

Prices of existing owner-occupied dwellings sold in July 2012 were on average 8.0 percent down from July 2011. This is the most substantial price drop since the price index of existing residential property was first recorded in 1995.

In real terms and indexed to 2005, home values are down 10.1% over the year in July and dropped 21.3% since the August 2007 peak.

Closely related to the depreciation of home values is underlying domestic demand.

The labor market is sinking, and taking with it household demand. Companies probably hoarded labor in the crisis – the peak to trough drop in GDP was 4.9% versus a 1.6% cyclical drop in employment around that period. However, in late 2011 employment peaked and unemployment is surging – the quarterly employment data through March 2012 indicate a peak was seen in Q3 2011.

On balance, the downtrend in Dutch home values is probably here to stay. FYI: the balance sheet of Dutch households and non-profits is roughly 2.5 times levered.

Rebecca Wilder

Eurostat breaks down the regional figures further into intra-Euro area (intra-EA) trade and extra-Euro area (extra-EA) trade.

Out of the EA 16, June intra-EA figures are available for just a few countries. Of those countries, the intra-EA trade balance improved in Portugal only, increasing by 0.26 ppt as a share of GDP on the month. From June 2011 to June 2012, where available, otherwise June 2011 to May 2012 (see Table above), the intra-EA rebalancing – i.e., roughly raising the balance of the net-importers and reducing the surplus of the net-exporters – has occurred to a certain degree. Net trade as a share of country GDP fell in Germany, and rose in Italy, Spain, Greece, and Portugal. France and Ireland worsened their positions, while the Netherlands increased its large trade surplus of 25.1% of GDP over the year.

Except in Portugal and Greece, the intra-EA ‘rebalancing’ is either not necessarily required due to the relatively low imbalances, Spain or Germany, or moving in the wrong direction, France or the Netherlands.

June extra-EA figures are available for all countries. With the help of the real depreciation of the trade-weighted euro over the month, the extra-EA trade balance improved in June across all EA 16 countries except for Ireland, where it fell by 0.2 ppt of GDP. Over the year through June, all countries except the Netherlands saw an improvement in the trade balance as a share of GDP (see Table above).

Given the strong positive momentum in extra-EA net trade and the sluggish shift in intra-EA net trade, I conclude that it’s the depreciation of the real exchange – the 12.7% nominal depreciation of the euro against the dollar, for example, and/or falling relative price levels with extra-EA economies - that’s the primary driver of the improving trade balances in key periphery markets. With the strong exception of Portugal, where the intra-EA balance improved by 2.6 ppt of GDP over the year, the internal (infernal) devaluation of repressing wages through high unemployment has mixed results at best.

Rebecca Wilder

Note: I understand the imbalances lie in the financial accounts as well but this post is dedicated to trade only.

A point on the data: all numbers are seasonally adjusted.

Data published this month showed that China’s exports to the European Union had sunk 16.2 percent in July to $29.4 billion, compared with July 2011.

This statistic (bolded by yours truly) is misleading.

First, China Customs measures exports in nominal dollars. If you look at Chinese exports measured in, let’s say euros, it doesn’t look quite as bad. In July, exports to the European Union (EU 27) dropped -3.6% over the year measured in euros versus a -16.2% annual decline measured in dollars. The dollar appreciated against the euro over the measurement period so the drop in China’s exports to the EU 27 is much lower in euros.

Note: This is only an approximation since I use the average monthly exchange rate, which is unlikely to align perfectly with China Customs’ measurement period.

An interesting corollary to the FX impact on ‘value’ statistics is the various statistical agencies that report presumably the same statistic. Eurostat publishes import data by partner and in euros. Using the average exchange rate over the month, I calculate the value of EU 27 imports from China reported in dollars for comparison to the China Customs data. Eurostat data is available only through June.

In June, Eurostat reports that EU 27 imports from China dropped -11.1% measured in dollars compared to the reported -1.1% annual reduction in exports from China to the EU 27 by China Customs. Clearly the trend is downward; but the Eurostat data only loosely matches the China Customs data. Balance of payments statistics are subject to large ”errors and omissions”.

Note: In the chart below, Eurostat data is illustrated in the series “EU imports from China”, while China Customs data is illustrated in the series “Exports to EU”.

So who’s right? Eurostat or China Customs? Part of the differentiation involves the timing of the FX moves (remember I use the monthly averages); but that is unlikely the full story here. I’d err on the side of Eurostat, and notice the trend looks pretty bad no matter who’s estimating the trade data.

Rebecca Wilder