Author Archives: Edward Hugh

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

Brief Latvia EU Loan Update

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Well, there is still effectively no word from the IMF. But The EC did today release an addendum to its memorandum of understanding with Latvia identifying a number of economic and fiscal policy measures it wants the country to enact before it receives next chunk of funding. The document, which is a pretty rough-and-ready PDF photocopy, can be found here. Reading the document, one thing seems certain: the upcoming tranche of 1.2 billion euros will not now be sufficient to cover the budget deficit for 2009, since the EC requires half of the money to be set aside for the financial sector – which prompts the question, is the nationalized Parex bank really as healthy as the government and the bank’s leadership have previously said it was?

Other items of interest in the document are the proposal to raise VAT in 2010 from 21% to 23% if other forms of revenue raising cannot be identified. The impact on already very hard pressed retail sales is not too hard to imagine. The introduction of a residential real estate tax is also proposed with local authorities being empowered to increase the real estate tax to 3% of cadastral values. If implemented, this will do only one thing: further reduce Latvian real estate values which are already down 50% from their peak, and on whose bottoming-out any hope of ultimate recovery depends.

Which is another way of saying that in macro economic terms the document leaves rather a lot to be desired, and essentially it is hard to find any item which is actually going to stimulate rather than flatten a recovery.

Also worthy of note is the requirement that Latvia now has to closely coordinate policy with the EU and the IMF.

“All significant Cabinet decisions or other decisions with a fiscal impact, including on social security or any guarantee scheme, shall be announced and undertaken only after discussions with the EC and the IMF,”

The document also stipulates that the government will have to report every month on all key aspects of spending and revenue, including providing a breakdown for each ministry as well as for local governments. These performance criteria, given the now near total dependence of the country on external support – de facto, as a sovereign state Latvia has effectively ceased (at least temporarily) to exist, some 19 years or so after its foundation – are not surprising in and of themselves, but it could have been hope that the country would have been better served in terms of the kind of advice which is being offered. The document repeated that Latvia should aim to reach a budget deficit of 10 percent of gross domestic product (GDP) this year, 8.5 percent in 2010, 6 percent in 2011 and 3 percent in 2012, numbers which, if my back of the envelope calculations are not totally awry mean that Latvia’s debt to GDP will be outside the EU 60% limit by the time the deficit comes down under 3%, depending on GDP performance in 2010 and 2011. In any event it will be touch and go. So you enter by one door, only to leave by the other.

IMF Imposes New Conditions On Latvia

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Izabella Kaminska at FT Alphaville has the story (via Reuters):

The International Monetary Fund has put forward new, difficult conditions for Latvia to receive further loans, the prime minister said on Wednesday in a further sign the Fund is being tougher than the European Commission.

It isn’t clear at this point what these conditions are. Rumour has it they may be an end to the flat income tax, or a hike in VAT. A hike in VAT would be more hari-kiri, since this would again hit consumption AND would boost inflation at a time when they are trying to deflate to carry through an internal currency correction. It also isn’t clear whether this is a serious attempt to add new conditions (which I find unlikely, given how advanced the distemper is) or whether this is a way for the IMF to get themselves off the hook (ie leave the EU Commission to stew in its own juice) without having a public and potentially damaging break with the EU. The IMF need to find some sort of exit strategy I think (since Latvia evidently at this point doesn’t have one), or it risks losing its own credibility if it puts a seal of approval (by granting the next tranche) on something which most external specialists now think could end up in a very messy grande finale. Argentina ghosts are stalking the corridors in Washington, not because of the similarities between the two countries (they are, at the end of the day pretty different), but because of the way giving a final “kiss of death” loan to a country can ultimately come back and haunt you.

Update One

The local Latvian news agency is saying that if Latvia and the IMF do not sign the new agreement by Friday, Latvia may not see the next chunk of the IMF loan and it could jeopardize the further funding from the EC. This could be brinksmanship, but even brinkmanship can go badly wrong if the other party can’t concede. And who is the other party here? Latvia or the EU Commission, since they already said they are happy with progress. What a muddle!

Update Two – Thursday Afternoon

Bloomberg’s Aaron Eglitis reports this afternoon that Friday may in fact not be any kind of deadline. He quotes Caroline Atkinson, head of external relations at the IMF, in Washington, to the effect that the head of the IMF mission in Riga is returning to Washington this weekend as scheduled, while the mission itself would “continue its work.” This suggests there will be no final decision this week. She also said there was “broad consensus among all the parties involved” about the goals for Latvia, declining to go into specifics.

Rumourology has it that the IMF wants the government to become more effective in revenue collection, with the fear that the current contraction may be so strong due to the fact that part of the economy is disappearing back into a “grey area” as a backdrop. Various proposals are being floated around, but perhaps it would be better to wait for some concrete information before speculating about this.

Latvian central bank Governor Ilmars Rimsevics has also been holding a press conference in Riga today, and he took the opportunity to suggest that the country’s budget deficit was likely to grow to between 9.5 percent and 10 percent this year. If this is the case, then this would obviously put Latvia outside the 60% gross debt to GDP criteria by 2010, which would make euro membership as an exit strategy non viable over the relevant horizon in my view. Just a long shot, but maybe that is what they are all arguing about. The EU clearly has to offer the four peggars more in the way of a carrot, although they themselves need to remember – looking over at Slovakia and Slovenia – that mere euro membership is no panacea to cure all ills.

Russia’s Contraction Eases But Knife-edge Risks Remain For 2010

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The Russian ruble strengthened the most in more than three months against the dollar this morning (gaining 1.7 percent to 32.2247 per dollar at one point) as oil rebounded above $60 a barrel and OAO Sberbank reported better-than-expected earnings. Sberbank shares jumped 5.1 percent after first-quarter net income turned out to be above analyst estimates. But the rise was also helped by the fact that Russia’s central bank spent approximately $2 billion from reserves to try to stop the ruble from falling yesterday, taking central bank reserve spending over the two working days since they lowered interest rates half a percantage point on Friday to around $4 billion, according to reports in the newspaper Kommersant.

Russia’s central bank cut its main interest rates for the fourth time in less than three months at the end of last week after the government estimated the economy contracted an annual 10.2 percent in the January-May period. Bank Rossii lowered the refinancing rate to 11 percent from 11.5 percent following on initial reduction on April 24 and two further cuts on May 13 and June 5.

But the striking thing here is that today’s ruble surge followed seven consecutive days when it fell – including yesterday when it dropped 0.5 percent against the euro and 0.1 percent against the dollar to hit the lowest close against the central bank’s currency basket since May 4. Indeed only last week the ruble posted its steepest slide against the euro and dollar since January as oil prices fell and Russia’s budget deficit contined towiden. And to top it all, as I say, the central bank reduced interest rates for the fourth time in less than three months. Continue reading →

The IMF/EU Commission Rift On Latvia Seems To Be Deepening

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Two weeks ago I drew attention to a revealing press conference given by IMF First Deputy Managing Director John Lipsky and European Central Bank governing council member Christian Noyer where it seemed a rather different posture was being taken on the Latvian question than that which is being transmitted from Brussels. Then P O’Neill found a message on Twitter which suggested the topic of the Latvian budget had been unexpectedly added to the EcoFin agenda.

Today Bloomberg report that Barclays Capital’s chief economist for emerging Europe Christian Keller thinks that the IMF’s posture of continuing to withhold funds even after the approval of the spending cuts “signaled that the rift between the IMF and EU has widened” .

Now I don’t want to see connections were there are none, but it is a coincidence that Christian Keller works for the same Barclays capital whose Head of Emerging Markets Strategy Eduardo Levy-Yeyati recently published a lengthy analysis on the influential Voxeu – entitled Is Latvia the new Argentina? – where he argued that: “The strategy of engineering an “internal” depreciation under a peg in Latvia (via contractionary fiscal policy, wage cuts and price deflation) implicit in the IMF program is proving too painful, if not self-defeating as in the 2001 collapse of Argentina’s currency board”

Now the publication of this article was interesting since Eduardo Levy-Yayati is not just any old economist. Previous to joining Barclays Capital, as his Voxeu biography informs us, he was

“a Senior Financial Sector Advisor for Latin America & the Caribbean at The World Bank. Previously, a Senior Research Associate at the Inter-American Development Bank, the Director of Monetary and Financial Policies and Chief Economist for the Central Bank of Argentina, and the Director of the Center for Financial Research and Professor of Economics and Finance at Universidad Torcuato Di Tella. He has also worked as consultant for the IMF, the World Bank, the Inter-American Development Bank, the Japan Bank for International Cooperation, among many public and private institutions. His research on emerging markets banking and finance has been published extensively in top international economic journals. “

That is, Señor Levy-Yayati is an extremely experienced economist, an old Argentina hand, and enjoys some considerable influence over emerging markets issues in Washington. So was the appearance of the article in Voxeu at the end of June totally coincidental? He certainly is experienced enough to know what he is doing in these matters. And was it also a coincidence that only a week later former chief economist at the International Monetary Fund Ken Rogoff – surely another person who knows perfectly well what he is doing – gave an interview where he said that “Latvia should devalue the lats to avoid a worsening of its economic crisis” and that “the IMF made the wrong decision when it allowed Latvia to keep its currency peg”?

The IMF cannot say what it really thinks for obvious reasons, but could we construe Levy-Yayati and Rogoff as thinking out loud on the funds behalf?

The clash between the two institutions (should such a clash exist) derives from “ideological differences” according to Keller. “The IMF is focused on economic questions such as the sustainability of the currency peg, the use of economic stimulus or the idea of fast-track euro adoption……The EU’s main concern is political, such as euro-adoption rules and the implementation of convergence programs”.

This all rings pretty true, and it rings even truer when you note that the Latvian Prime Minister Valdis Dombrovskis said only last week that the country “may not need the IMF share of the financing”. As Keller says, “The Latvia program has become a headache for the IMF.” Continue reading →

Cliff Hanging In Bulgaria

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The International Monetary Fund this week forecast the recession in Bulgaria would be deeper than it previously predicted. Such a decision should come as no surprise to anyone, since the country’s economic dynamics in both the short and long term look extremely unstable, and Bulgaria is now almost certainly headed towards a series of more or less hair-raising roller-coaster rides. Even the briefest of glances at the population chart above should lead all but the most sceptical among us to stop and think a little about the possible economic implications of such an appauling demographic outlook. As can be seen, the opening to the west brought a sharp outflow of people in the late 1980s (mainly ethnic Turks), but the important thing to note is that the decline has continued almost continuously ever since. That is, the decline was not a one-off demographic “shock”, but rather it has become a way of life (or, if you prefer, of death, since deaths constantly outnumber births, even before you consider emigration). And it is this “terminal style” dynamic which virtually guarantess that the coming ride will be a bumpy one, not only in the short term (guaranteed by the size of the current account deficit – 25% – which Bulgaria needs to correct) but in the longer term, since according to any known growth theory there is simply no way any country can sustain headline GDP expansion with potential labour force and population contractions of this magnitude lying out there in front of them. Continue reading →

Who Said Economists Didn’t See The Crisis Coming?

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Question: who said this in 1990?

“For about 15 years, the United States runs current account deficits, so that more than 6 percent of U.S. assets are owned by foreigners in 2010. High saving for the subsequent 15 years results incurrent account surpluses and reduces foreign capital ownership to 3.5 percent. Past 2020, however, with the rapid increase in the number of elderly, the United States again runs current account deficits, so that in the steady state almost 9 percent of U.S. assets are owned by foreigners.”

Answer, among others the current director of the US president’s National Economic Council, Larry Summers. In this monster article (An Aging Society: Opportunityor Challenge? – be warned large PDF download) written with David M. Cutler (Massachusetts Institute of Technology), James M. Poterba (Massachusetts Institute of Technology), and Loise M. Sheiner (Harvard University) and published in Brookings Papers On Economic Activity.

The whole thing is incredibly wonkish, so perhaps you won’t want to read it, but it is there, even if some of the details are wrong, and, remember, he is only talking about a model, and what it predicts. On the other hand the whole piece is extraordinarily prescient, even foreseeing the decline in US savings and their recovery (which of course is associated with the movements in the current account).

Basically, Summers et al are only saying (but 20 years earlier) what Claus is saying in that pesky chart I keep insisting on putting up (see below).

But now that you are getting used to looking at it perhaps the time has come to explain a bit more about it. Summers et al spoke about a new steady state (where the US again reverts to current account deficits). This is the situation Finland, for example, may be near too. But if you look at the chart, this is not a steady state, since their is no homeostatic correction mechanism this time, and the need for exports (the export dependency purple line) simple heads off exponentially towards infinity, while the level of deficit does the same in the opposite direction.

The reason that the need to export moves exponentially upwards is that median age doesn’t just move up from one level to another, and sit there, but keeps climbing steadily upwards, and the more it rises, the less bang for the buck GDP growth you get from any given level of exports. This is the situation we are seeing now in Germany and Japan, and it is evidently not sustainable. So, if we don’t do something, and do something now, to stop median ages rising too rapidly, then more crises are guaranteed, and the next round will make this crisis will seem like, now how do they put it, oh yes, a picnic.

That this way of thinking about things is one piece in the new, post-crisis, macro mindset that will emerge, I have no doubt, since the crisis is all about imbalances, and this is one model for understanding them. Basically one group of people – the current account surplus people (China, Japan, Germany, Sweden) – were afloat with money, and spent their time recklessly lending it to another group of people – the current account deficit crowd (you know, the United States, Iceland, Ireland, the UK, Spain, Portugal, Greece, Romania, Bulgaria, the Baltics, Hungary and New Zealand etc, etc) – who needed to fund their deficit habit, and did it by equally recklessly borrowing money. So if you want to understand the banking crisis, you need, as Brad Setser would say, to follow the money and find the surpluses and deficits.

And all of this helps us understand not only the crisis, but also the problems we are going to have getting out of it, since as Larry Summers noted over lunch with the FT’s Chrystia Freeland “‘The global imbalances have to add up to zero and so, if the US is going to be less the consumer importer of last resort, then other countries are going to need to be in different positions as well.’

As Freeland highlights, on this possibility, Summers is bullish. “The very great enthusiasm for accumulating reserves that one saw globally is likely to be a smaller factor over the next decade than it has been in recent years” he predicts. And so too is economic growth (going to be a smaller factor over the next decade), Edward Hugh rapidly adds, since with everyone looking to export their way out of trouble, we have to ask, as Krugman pointed out, the tricky question about just who the customers with the current account deficits are going to be to enable all the exports. There is a long hard road ahead.

And the first evidence of this can be found in yesterdays US trade report, May exportswere up 1.6 percent, while imports were down 0.6 percent resulting in the smallest trade deficit since November 1999. Well, this is what the world wanted, and this is what it is now going to get. So everyone should be happy, I guess.

To The Finland Station And Back Again

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This post accompanies my recent piece on Sweden. I have been scratching my head and trying to see what could be learnt from making a comparison between Finland and Sweden. Some of the differences are obvious – one is in the euro, and the other isn’t, once can adjust monetary policy and currency values, and the other can’t. Others are less so. Finland’s goods trade surplus has been declining steadily since joining EMU while Sweden’s has remained relatively constant. And Swedish males live on average three years longer than their Finnish counterparts. So what is important here, and why? And if convergence theory has anything positive to be said for it, shouldn’t we be able to observe so sort of convergence going on here. Continue reading →

The State of Sweden’s Economy At A Glance

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Basically this post accompanies my earlier Swedish monetary policy and Sweden devaluation ones. First some theoretical structure from Claus Vistesen.

As we can see above, the idea is that as median population age rises the current account dynamics of a country change. The last ageing phase of the diagram is purely speculative at this point. Basically we simply do not know what happens after a society starts to dis-save at an advanced median age. We have, as yet, no experience with this phenomenon.

Now, as is well known, Sweden’s median population age has been rising steadily, and reached 41.3 in 2009 according to the latest estimates from the US Census Bureau. This makes it a little younger than Germany and Japan (ma circa 43) but still over the critical 41 threshold (which is itself a tentative first estimate, and still needs calibrating from case to case).

Continue reading →

State of the Art Monetary Policy In Sweden

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Animated by yesterday’s export driven PMI result, Sweden takes poll position in quantitative easing and commits to keeping 0.25% rates on hold till the end of 2010. Mind you, they are lucky enough to have Princeton economist and avid deflation fighter Lars Svensson in there on the board to steer them through all this. Good for Swedish growth, Krona negative, great for exports. Let’s go, let’s go, let’s go.

Sweden’s central bank cut its key interest rate by 25 basis points to a new record low of 0.25 percent in a surprise move on Thursday, and said it would offer one-year loans to banks to foster lending. The Riksbank said it expected interest rates to remain at that level until late 2010. Deputy Governor Lars Svensson disagreed with the decision and advocated a cut to zero. Nearly all economists in a Reuters poll had expected the Riksbank to keep rates on hold at 0.5 percent, in line with a previous central bank forecast that suggested rates would stay around that level at least until early next year.

“The repo rate is expected to remain at this low level until autumn 2010,” the central bank said in a statement. “The Riksbank’s assessment is that after cutting the repo rate to 0.25 percent it will have reached its lower limit in practice, and that the situation on the financial markets is still not completely normal. “Supplementary measures are necessary to ensure that monetary policy has the intended effect.” Those measures entailed offering 100 billion crowns’ worth of loans to the banks at a fixed interest rate and a maturity of 12 months. “This should contribute to lower funding costs for the banks and lower interest rates for companies and households,” the Riksbank said.

The reaction on the Krona front was swift:

The Swedish krona fell against the euro after the country’s central bank unexpectedly cut its main interest rate. The krona weakened 0.6 percent to 10.7868 per euro as of 9:32 a.m. in Stockholm. The Swedish currency depreciated 0.9 percent to 7.6527 against the dollar. The Riksbank lowered its main rate by a quarter of a percentage point to 0.25 percent. All but one of 17 economists surveyed by Bloomberg forecast no change.

Some people have been saying in response to warnings that this recovery will be export lead, “exports what exports”? What a load of tripe! Without exports there will be no recovery. The next lesson in abc economics: in times of crisis relative currency values matter more. And to prove it, Swedens PMI just poked into the growth zone, 50.5, following 43.7 last month. The 17% odd devaluation with the euro would have nothing to do with this, would it? Welcome Sweden, the worlds fourth 50+ PMI.