Month: September 2010

Irrational Bond Markets

The post hoc attribution of market movements to specific events is always a bit speculative. But Thursday’s release of weak Q2 national accounts (Economy Shrinks Shock!) was headlined in Irish and international media and appears to have unsettled the secondary market in Irish government bonds. The 10-year closed around 6.65 on Friday, the worst close of the crisis to date and cue panic stations.

This makes sense if

(i) The prospective growth rate in 2011 and later is critical for fiscal sustanability, which is reasonable, and

(ii) A sensible person would have revised their expectations on the basis of Thursday’s release, which I think is not reasonable at all.

So far as I know, there have been just three technical studies of the Irish quarterly data since the CSO commenced publication in 1997 and which are relevant to this discussion.

In this paper, the conclusion here is that the Irish quarterly GDP and GNP numbers are very volatile, and considerably more so than is the case in other OECD countries, including smaller ones.

This study concludes that the seasonal adjustment procedure used by CSO is (probably) not the best, and that this can make a difference, in the sense that an alternative, and preferable, procedure can give results which sometimes alter the qoq % changes quite a lot.

The final study shows that revisions to the first-shot estimates, while no greater than elsewhere, can be substantial.

The economy sank like a stone through 2008 and 2009. The last three qoq % changes in real GNP, using the CSO’s seasonal adjustment, were -1.9, then -1.2 and just -0.3 for the most recent Q2 number. Using the alternative (indirect) seasonal adjustment, the most recent number was -0.1. A reasonable headline in either case would have been ‘Economy Now Flat’.

The reason for the Shrinking! headlines was the GDP numbers. The last three qoq changes read -2.5, +2.2 and -1.2. These are the qoq changes, not annualised. At seasonally adjusted annual rates (saar) the decline in real output in Q4 was -9.6%. It then grew at a saar of +9.1% in Q1 of 2010, relapsing to a saar of -4.7 in Q2. If you really believe this, maybe you could make it as a bond dealer.

The gyrations in the quarterly numbers are just not credible. Various people including Garret FitzGerald and Robbie Kelleher have speculated that real output measurement in the MNC sector is mainly responsible for the extreme volatility. There may be a bit of informal smoothing practiced by other countries too.

Forecasts of GDP growth for 2011 seem to be mostly in the 2% to 3% range. My point is not that these forecasts are likely or plausible. The point is this: given what we know about the behaviour of the Irish quarterly macro aggregates, whatever your figure was on Wednesday, there was no good reason for changing it on Thursday morning.

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Low Tax Levels

Garret Fitzgerald writes on the Irish tax system in today’s Irish Times: the article is here.

Geothermal energy in Ireland

GT Energy has applied for permission for a deep geothermal power plant in South Dublin. This has attracted some media attention (here, here, here) and Paul Cunningham cast me in my standard naysayer/party-pooper role.

The media attention is overblown. The project is small. It is only an application for planning permission. The legal framework for exploiting these resources has yet to be designed. Subsidies for geothermal power are zero at present.

The cost of geothermal energy depends, to a large extent, on the depth of the hole that needs to be drilled to get to the heat below our feet. In Iceland, Mother Nature nicely brings the hot water to the surface. GT Energy plans to drill 4 kilometers deep in South Dublin.

Unfortunately, Ireland is at a geological disadvantage in this regard (although mercifully free of volcanoes by the same token). As shown on this map (peer-reviewed version here, but in B&W and behind a pay wall), you’d need to drill deeper in Ireland than elsewhere in Europe to get to the hot stuff.

Therefore, if GT Energy can get this to work at a profit in Ireland, they’d be best advised to apply the technology elsewhere and make buckets of money. I will not invest in their company, but others are free to try their luck.

Peter Sutherland on the Irish Economy

The text of Peter Sutherland’s speech to the Institute of Directors is below:

Notwithstanding the successful auction of €1.5bn of government debt on Tuesday, there is no doubt that in recent weeks (and in particular in the last two weeks), Ireland’s position in the debt markets has deteriorated markedly and the sale came at a high cost. This has been the consequence of a number of factors. Some of these are objective facts about the dire state of our public finances. Others are the result of market perceptions. It is hardly surprising at present that there is an air of fatalism consistently nurtured by negativism but it is surely not in our character to give in to this. We can and will get out of this mess if we have the will to do so.

Let me say a word first about market perceptions. We seem to have a remarkable capacity to damage our public image abroad. The prevailing and understandable sense of depression in Ireland is made worse by a media often seemingly intent on presenting the worst perspective on current events. The recent Barclay’s analyst report, which was wrongly presented by some in the Irish press as being far more negative than it actually was, is a case in point. You may say, “Well so what? Those professionally concerned with our credit worthiness surely do not decide their approaches on the basis of second hand commentary on an analysts report?” Well, yes and no. The national media reaction is taken seriously and market reactions are often instantaneous.

It is time that we separated two big issues, the underlying budget deficit and the bank crisis. The first of these presents a very challenging issue but it can be dealt with if we have the collective will to do so. The collective will can only result from an understanding of the facts. We are running a revenue to spending gap of circa €20 billion p.a. and simply cannot continue to do so. As Willem Buiter, formerly of the London School of Economics, said this week, the cost of borrowing is becoming unsustainable. Our national debt is accumulating still at an alarming rate as a result of government spending but is being obscured as an issue in public debate by the constant and intense focus on the nature and effects of the banking crisis. Terrible though these are, they are identifiable and should be considered separately.

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