Firms' cash flows

3rd draft of the thesis is done! My supervisor is reading it over and I hope he will be all right with it. Will meet him in two weeks or so, until then, it's time I revive this blog a bit!

Statistics Iceland issued, not long time ago, new data covering the cash inflows of Icelandic firms, based on their VAT reports. The bottom line: the nominal value is back up above pre-crisis levels in 2008 but the real value is still lingering below. There is a steep spike in the real cash flows however so the firms-part of the economy is picking up pace.

This is the nominal value of firms' cash flows. The sample is smoothed out with a running average. Notice the stagnant period in 2001-2003 when nominal cash flows were hardly or not growing at all. That compares to the 10% drop in nominal cash flows in 2009. 

Firms' nominal cash flows

This real cash flows story is another one a bit more frightening. Suddenly, the drop in 2009 has stopped being violent and has turned into a battle for existence!

Firms' real cash flows, 2012 price level

What is curious is to see where the drop comes from. And the answer: from the burst of the housing bubble. On the graph below we can see how industries have rocketed upwards as a share of the firms' total cash flows. At the same time, cars and car repairs have trended downwards for a long time. Most notably however, we can see that after the housing bubble burst, the "construction" has basically disappeared.

Graph shows how firms' total cash flows are split based on what they're doing. The burst of the housing bubble is rather obvious

The burst of the housing bubble is even more blatant in the next graph. Since 1970, the construction of residential housing has never been as low. That is so even if Icelanders are now 319,000 compared to 204,000 in 1970.

Number of square meters in new residential houses and flats, begun and finished, in each year. If you're a carpenter looking for a job, don't come to Iceland!

Of course, we can see on the sectoral cash flow graph that it is the Industries (manufacturing) that have kept the economy alive since the implosion in 2008: total value sold of manufactured goods doubled between 2007 and 2011 (reaching 727 billion ISK in 2011). Most of this comes from manufacture of basic metals (the smelters) but food products and beverages (the fishing industry, we've also become producers of many different brands of beers!) have done their parts as well.

I don't think anyone will deny that the utter collapse in the value of the krona helped industries keeping the economy alive. At the same time, the strengthening of the krona during 2002-2007 can be blamed at least partially for the deterioration of those same industries in that period. In the meanwhile, the housing bubble and the credit mania kept the economy going while the krona was too strong.

Maybe next time I'll check out the data for e.g. France and Spain but both economies had/have a housing bubble (don't tell me Parisian house prices are sustainable!) and then an economic slowdown, Spain in particular of course. Ireland would be a nice comparison as well. Have industries in Spain, Ireland and even France refuelled the economy to the same extent as has been the case in Iceland after the implosion in the housing market? Based on the prominent discussion about the growing current account deficit in France, I'm going to doubt it in case of her - at least until I see the data.

"At Dawn" on Bylgjan Radio

The long silence here is explained by the fact that I've been working on my PhD like crazy for the last weeks. The last chapter does not write itself. It is coming to an end though, one day this will all be finished!

Was on the phone in the radio show "At Dawn" this morning at Bylgjan radio back home. The topic was the pension funds and the idea of a member of parliament, Mordur Arnason, to give people the choice to use their monthly payments into their own pension fund to pay up their mortgages. So instead of forming rights within the pension system, people would pay down their debts instead. 

I pointed out that Arnason's idea was simply based on the fact that the yield pension funds are getting, costs etc. taken into account, is only around 2.5%-3.0% (real interest rates). In the meantime, mortgages in Iceland carry 4-7% real interest rates. So why not pay back your debts first and then build up your rights within the pension system?

Thorhallur Josepsson from The Pension Fund of Commerce was in the studio. He agreed with me that Arnason's idea deserved some serious thinking. But he didn't agree with me entirely, at least not when I said my opinion on the general structure of the Icelandic pension system and when I commented on the funds' need to get 3-4% real rate of return if they were going to be able to stand by the promises they are legally obliged to.

The clip can be found in the link below (Icelandic).

Í bítið: Iðgjöld notuð til að greiða inn á höfuðstól lána

Wages in Iceland According to the Tax Man

A Facebook friend of mine posted data on there about the gross wage income of tax payers for the last years. The data got me thinking and I came up with the two graphs below.

Explanations are in order. First, the data is gross pre-tax income in the form of wages, including wage-benefits (car sponsorships etc.) and pension payments. The gross income amount is divided by the number of those persons that posted that income to the tax man. Furthermore, the years are the years of which the income took place. The data comes from this Facebook friend of mine, Elias Petursson, and he has it from the Directorate of Internal Revenue (a very cumbersome name for the tax collector).

So in 2007, the average tax-record-maker made nearly 4.8 million ISK in pre-tax income (2011 prices). That is equivalent to 58 thousand USD (again, in USD 2011 prices).

But then came the crash. In 2008, the average gross pre-tax income had fallen down to 4.5 million ISK. The figure went on downwards, bottoming out in 2010 at 3.75 million ISK. A mighty fall of 21% in pre-tax gross income in only three years! Only last year did the pre-tax gross income increase, but it is still 18% lower than it was in 2007. And this excludes all the effects of the tax hikes!

But there is more. The collapse of the currency by 50% - you needed 64 ISK to buy 1 USD in 2007, in 2011 you needed 116 of them after having bounced back from the 124 ISK/USD low in 2009 - decreased the purchasing power of the average Icelander abroad significantly. The 58 thousands USD gross pre-tax income in 2007 turned out to have become only 33.5 thousands in 2011.

The pre-tax income of the average Icelander has decreased significantly since 2007, both in ISK and USD alike. Red is the USD figure in thousands, on right axis. Blue is ISK in millions on left scale. Both figures are detrended with the respective price index and all figures are in 2011 prices.

Now, the axis on the graph above don't add very much detail. If we however make an index out of the figures, we come up with this.

The pre-tax gross income of the average Icelander has decreased by 18.3% since 2007. Measured in USD however, the fall is 42.7% since 2007. Notice the slow upward move since 2009 though. Again: USD in red, ISK in blue (fixed prices)

So the populace of the IMF Wunderkind has had to settle for a contraction in USD-based gross pre-tax income of more than 42%. Well, we can always look at the bright sides: since the USD income bottomed out in 2009, the growth is 12.3%. Maybe there is something behind the GDP growth figures after all.

Yet, I must wonder what happens once we take the tax burden into the account.

The Optimistic GDP Forecasts and IMF's Turnaround

Islandsbanki published its economic forecast for the Icelandic economy late in September. Their expectations: 3.2% growth in 2012 and increasing after that.

I sat down and looked at some other forecasts in comparison to get a feeling for the realism behind them. I cannot say that any of them is realistic for 2012 except the IMF one. And funny enough, IMF is in fact turning around on its policy on Iceland and the problem we have on "offshore" kronas. IMF isn't as optimistic about its wunderkind as they used to be when they threw that "Iceland and IMF" conference one year ago.

GDP forecasts range from 2.4% (IMF) to 3.2% (Islandsbanki) in 2012. CBI stands for Central Bank of Iceland.

OK, so the range for 2012 is 2.4% to 3.2%. That compares to 2.4% GDP growth the first 6 months of 2012 compared to the same period the year before. That means that to reach 3.2% growth (Central Bank of Iceland (CBI) and OECD expect 3.1% growth in 2012) the economy needs to grow by 4.0% in the second half of 2012.

4.0%. Right. Well, that's not going to happen. Islandsbanki's 3.2% expectation is way off, we can immediately write their 2012 forecast off. Same really goes for CBI's and OECD's 3.1% forecast.

The most interesting forecast is IMF's. It's interesting not only because it is the most realistic one but it also signifies a turnaround on IMF's behalf when it comes to Iceland.

IMF in 2011: "We nailed it!"
In August 2011, IMF projected 3.1% GDP growth in Iceland. It expected 2.5% growth for the full year 2011, which compares to the latest estimate of 2.6%. Well done! IMF generally expected "a tentative economic recovery": the inflation was rising, the krona depreciating slowly and uncertainty was (and is) still high due to the Icesave dispute. However, "access to international capital markets [had] been regained" and "outlook was for a moderate expansion" while "concerns persist about the sources of medium-term growth." IMF constantly mentioned the growth in private consumption, an economic factor that practically caved in in 2009 and 2010.

But the most prominent IMF position was that of the handle of the crisis. A whole conference was set up in October to celebrate the good job done and famous international economists came to Iceland to check out the crisis Wunderkind. In November 2011, IMF's eyes to the possible unorthodox handling of the crisis had opened and Iceland's case suggested "alternative way out of crisis."

Iceland had basically taught IMF that atypical "we must save the creditors!" policies weren't the only one available. Good stuff, very important that IMF realised this.

IMF in 2012: "We nailed it BUT..."
Now, IMF has realised that it may have to extend even further the Icelandic case of "let the creditors drown". The reason: the offshore kronas.

The offshore kronas are funds, denominated in krona, that are stuck in the economy behind the capital controls. Their sources can be of any kind, ranging to the Glacier bonds issued during the 2004-2007 Party to normal households' savings that are eager to get out of the economy on expectations alone that the value of the krona will collapse the instant the capital controls are lifted. Estimates of the whole offshore krona amount run from 400-1,000 billion ISK (25%-60% of GDP or thereabouts).

On 28 September, IMF issued a Concluding Statement. There, we can see IMF arguing that "significant reduction (or elimination) of the “overhang” of liquid offshore krona" is one of the preconditions for lifting the capital controls. That was always known. What is a turnaround is the way IMF is now willing to do it:

"To accelerate [reducing the stock of liquid offshore krona] it is necessary to strengthen the incentives for holders of liquid offshore krona to participate in the liberalization strategy. A key step will be to curtail expectations that capital controls will be lifted soon, including by removing a reference in legislation to a terminal date for the controls. In addition, the strategy should clarify that the conditions under which liquid offshore kronas are allowed to exit will become less favorable over time

And they continue:

"Once incentives are in place, the authorities could open the next channels envisaged in their strategy—bond swaps and an exit tax. The objective of the bond swaps would be to reduce the stock of offshore krona before introducing an exit tax and ultimately lifting the controls. Swapping short-term krona-denominated assets into long-term euro-denominated bonds would distribute the pressure on the balance of payments over several years."

This is a turnaround. IMF is now accepting the not-so-unlikely possibility that in order to ever lift the capital controls in Iceland, the Icelandic authorities basically have to fry the creditors even more. IMF padded Iceland on the back for not rescuing the banks in 2008 and thereby let the creditors of the banks take the hit. Now, they are directly saying that Iceland would need to take one more step and straightforward threaten the holders of liquid offshore krona: "the strategy should clarify that the conditions under which liquid offshore kronas are allowed to exit will become less favourable over time."

IMF changing?

The funny thing is that those ideas are old. One of the MPs of Iceland, Lilja Mosesdottir, has for a long time urged a more critical stance on the offshore krona issue. She has spoken about a German-1948-type adoption of a "new krona" (assets in ISK redenominated in a new currency, which's exchange rate is a function of the nominal value of the asset being redenominated, e.g. 1:1 for low amounts, wages, etc. but 10:1 for high amounts and offshore krona) and an "exit tax" if offshore krona owners want to swap them out for EUR or any other foreign currency. She in fact used to be in the government but went rogue due to what she felt was the government's softness towards IMF. 

Now, IMF has basically taken up her stance.

And why? Maybe because they are afraid that their Wunderkind isn't in the good shape they hoped to.

But maybe because they are generally accepting the fact that "debt that cannot be repaid, won't be repaid" and creditors should simply accept it. That would be the most wonderful thing if IMF finally realised that and actively applied that policy in its future bailouts.

House Prices in Spain and Mortgages

Not that it isn't something that most people already know but the house market in Spain is imploding. Awesomely! Most people of course realise that this is connected to the nuclear winter in the mortgage market in Spain: no mortgages,  no house sales and certainly no increments in house prices.

I sat down and did a bit of data cracking. The correlation between the contraction in mortgages and the implosion in the house market quite frankly startled me.

First, lets see the reduction in the number and amount of new mortgages in Spain. Data comes from Statistics Spain and EuroStat.

New gross mortgages in Spain and their number. Non-amended data.

Next, we can see that the house price index seems to follow the total gross new mortgages downwards.

New mortgages (12 month moving average) and the house price index in Spain

But what is seriously scary is the correlation between the change in house prices and the change in new mortgages. A correlation of 0.99 is practically unheard of!

The fall in the house prices is due to the utter collapse of the mortgage market. The dire deflationary spiral in the housing market in Spain is almost perfect!

Good luck turning this around with a bit of austerity!