European Quantitative Easers Let’s Talk

The Eurozone sovereign debt crisis is posing a real challenge to Europe’s policy makers. The un-abating liquidity squeeze on government borrowing is threatening to turn into a solvency crisis in which more Eurozone countries are at risk of defaulting on their debts. The interest rates at which governments are currently borrowing are for the most part unsustainable, with countries like Italy and Spain borrowing at dangerous levels previously reserved for the smaller members of the PIIGS group. Broadly, two schools of thought have emerged with solutions to the problems at hand, one we will call the Monetary Keynesians and the other the German School of thinkers. The former are represented by such personalities as Roger Bootle of Capital Economics, the famous Dr Doom Nouriel Roubini and the New York Times Econom ic’s Nobel Prize winner Paul Krugman, while the latter are represented by the likes of the resigned ECB Governing Council members Axel Weber and Jurgen Stark.

The first group is advocating using the printing press and nationalizing (or federalizing) distressed sovereign debt. That is to say they want the Eurozone, through the ECB, to print money to by debts that can’t be paid back by member countries who spend more money on goods and services than they produce. The excuse found to justify this action is that the fledgeling economies are actually able to produce enough wealth to sustain their social systems but that because of a temporary bleep of liquidity issues they need temporary help. Nothing could be further from the truth. France to name just one of the irresponsible countries (although not yet a crisis country) has not passed a balanced budget since 1973! Greece has lied about its overspending for years prior to the crisis and the Eurozone as a groupe only managed a budget surplus in 2001 in the last 20 or more years. What does this say about European fiscal rectitude? it says that it doesn’t exist the Eurozone has always had a structural deficit. The sovereign debt crisis has been in the making for a long time, the Keynesians excuse that it is a temporary problem needing papering over is bogus.

Not just bogus but also internally inconsistent. Keynesianism calls for counter cyclical fiscal policy, while american liberals like Paul Krugman say that pro growth spending is positive in bad and good times alike. In any case the Greeks have proved that policy wrong. Another solution proposed by the less hawkish of economists is to have the ECB double down on its LTRO or renew its sovereign bond buying program. Imagine the ECB mostly backed by Germany buying Spanish, Portugese or Italian bonds. Now imagine investors believe that the problem remains unfixed and that primary deficits can’t be fixed by liquidity improvements, yields will continue rising and bond values will continue dropping. The ECB will either have to print money to paper over its loss sparking inflation or it will have to beg the big Eurozone economies to bail it out. Now assuming Europeans remember what low growth high inflation looks like (see 70’s and 80’s) they will surely stay true to their feelings of entitlement and choose to pressure the Eurozone core to pay up.

Now the Germans, Finnish, Dutch et al. have already shown their distaste for profligate Mediterraneans’ bail outs, so does anybody really think the ECB will go down that road? Well you’d be right if you think it might happen, with all the German resignations at the ECB, the institution seems to be loosing its hawkish edge. Forget the stellar inflation busting record under Trichet, the ECB is going south.

These are disappointing times for some economists, the world is awash with exemples of virtuous macroeconomic policy and yet some continue to advocate tried and failed policies or policies that are untried and risky. Why does no one point towards Canada where austerity in the nineties have led to stable government expenditure levels today, or Germany where austerity was imposed, unit labour cost were lowered and how about Estonia which consolidated spending massively in the face of a deep contraction in output and today is one of the Eurozone’s fastest growing economies. The Eurozone periphery is small enough that deep primary-surplus generating government spending contractions wouldn’t affect he currency zone as a whole too deeply. Portugal and Greece could have been the next Estonias, instead talks of bailout and quantitative easing has inspired periphery politicians to stall and not make the necessary decisions for growth.

The PIIGS, France and all other fiscally week Eurozone countries need to do three things: stop dithering and waiting for someone else to bail them out. They need to emulate Mario Monti’s drive for competitiveness, shoot for growth and competitiveness. Then they need to emulate the tiny Estonian country and actually start generating budget balances through lower expenditure and not through heightened taxes. What the rest of the World needs to do is stop giving ball-less politicians excuses for their failures and easy solution proposition. The road to wealth has already been traced, it’s time Europeans stopped pretending they are smarter than the rest of the World and American liberals need to open their eyes to the reality that free lunches dont exist and the hard road is the better road!

Here’s a Suggestion Mr Carney

The governor of the Bank of Canada Mark Carney has again continued to scold and give lessons to Canadians. He does this in his Monetary Policy Report of April 2012 where he reiterates some of the comments this blog criticized in a previous post. Those comments were that Canadian exporters needed to retool and refocus and that Canadian consumers needed to slow their pace of debt accumulation. The focus of the ‘retool, refocus and retrain’ mantra is largely advocated so as to increase Canadian firm’s ability to compete internationally and export. While this blog has already stated its objection to paternalistic economic communication from government institutions towards the private sector, this blog does accept Carney’s view that Canadian prosperity is underpinned by healthy trade numbers and international competitiveness. There is one criticism the Governor could have levelled that balances private sector independence and improved competitiveness, that critic should be less debt supply and it should be levelled at governments.

Talk of trade competitiveness unfortunately always boils down to currencies. In Canada manufacturers and commentators are always complain about the high Canadian dollar and how many jobs it kills. Leaving aside the fact that a high currency has as many benefits for a country as it has costs, a currency artificially above its equilibrium (or below it for that matter) is however  a concern. Let’s assume that the Canadian dollar is artificially overvalue, who might the culprit be for this imbalance? The Loonie isn’t a reserve currency so that can’t be it. Contrarily to McGuinty’s opinion oil isn’t to blame either. As the Central Bank report notes, Canadian oil is sold at a steep discount to certain international oil benchmarks, meaning that eastern Canada imports at high prices while the west exports at cheap prices, so the impact of higher oil prices only marginally affects the Canadian currency. In any case studies have refuted the claim of the Loonie being a petro-dollar. So who exactly is contributing to the Canadian dollar remaining above par with the US dollar?

To answer that question the certain economic facts need to be reviewed. Commentaries on trade and currencies often emphasize a restricted number of causes for currency fluctuations. Currency movements need to be understood in terms of foreign exchange market equilibrium. Every currency trade impacts the prevailing exchange rate but every trade does not just involve a quick speculation or an oil contract purchase. Much purchasing and selling of currencies involves savings diversification by institutional money managers. To give some colour to this point in 2007 before the crisis hit, foreigners shed roughly ~10 Billion of government paper while exporters sold just over 460 Billion dollars of exports. Since the beginning of the crisis over 400 Billion of Canadian government financial papers have been sold to foreigners. What does all this mean? Government budget surplus reduces the supply of government debt available to foreigners for purchase, a government deficit increases the supply. Since foreigners must buy Canadian dollars to purchase both export goods and government debt, Canadian governments’ profligacies are partially to blame for the high Canadian dollar. Part of their issuance of debt has been sold to foreigners increasing the demand for the Loonie and crowding out exports of goods and services.

Some might be tempted to point to Europe to refute these assertions. They would note Europe’s deficits have widened since 08 while the Euro has generally fallen. This is easily explained by sovereign risk. Canadian government debt is perceived to be a safe investment while much of the Euro area’s debts are considered very risky. Investors the World over generally prefer to buy Canadian debts than those from the PIIGS as they could be described as better quality products. Essentially Canada’s two most popular exports have now become oil and debt, small wonder manufacturing in Ontario can’t keep up. So if Mark Carney is so considered with the twin problem of profligacy and competitive weakness why isn’t he calling for Government austerity?

IMF Going All Out Keynes

Keynes once opined that in an effort to boost aggregate spending the government should hire unemployed workers to dig holes, bury money in them and then hire more workers to unearth the cash. In a similar verve, Ben Bernanke illustrated his thoughts on monetary stimulus by proposing to have helicopters drop money on neighbourghoods where spending falls the most during recessions. Following in this intellectually rigorous train of thought is the International Monetary Fund. In chapter 3 of its April World Economic Outlook The IMF submits research on housing slump prolonged recessions. They come to the conclusion that housing slumps following recession prohibit or even reverse consumption resumption. That is to say if your house looses half its value (a.k.a. your average Joe lost half his life savings) as a consumer you’ll probably pull back from spending. That this wasn’t obvious to one of the most important institutions of the global economy is in itself a source of worry. More worrying still, is the solution proposed.

The fact that government interventions in housing markets is not recognized as the main culprit of the last crisis is a sad fact on its own. That governments are being asked to further expand their lack of clout over real-estate markets is simply despairing. The IMF’s proposal is for governments to develop debt forgiveness schemes for distressed homeowners during recessions. Their rational is that when recessions occur income drops, leading to an initial drop in demand for housing and an increase in supply. This in turn drives down home values. As leveraged homeowners home equity turns negative they begin to default on their mortgages. This is exactly what happened in the States. The IMF believes that a vivious circle develops whereby drops in home values curbs spending and increases defaults leading to net wealth compression leading to more  drops in consumption and so on and so forth. The IMF believes that if corrections in housing markets can be mitigated, output slumps will be less severe.

This is all true. The problem is the part on mitigating housing price drops. The IMF thinks governments should do that and they propose it should be done through debt forgiveness schemes. Now, one might ask if it were so easy why in the hell haven’t banks done this already? The IMF would argue its some perfectly competitive market where banks are afraid of individually doing the debt forgiveness effort and other banks profiteering from said efforts. Two things, first collusion is illegal so of course they wouldn’t start a debt reduction country club and second, because it’s stupid. Banks are in the business of evaluating what levels of debt are appropriate that’s their job! If it was a good idea to reduce debts they wouldn’t need the IMF’s politburo encouragements to do it.

More seriously however is the moral dilemma argument. If banks or countries start instituting debt forgiveness schemes consumers will have an incentive to over pay for homes in expectation of a market correction. This will fuel higher prices and housing bubbles which were the source of the problems in the first place. One might argue that the laws governing home defaults in the US act as a de facto debt forgiveness mechanism. As their home equity turned negative Americans had the legal cover to rationally decide to walk away from their homes when their equity turned negative. That mechanism is partially to blame for the savageness of the housing downturn in the US.

So let’s recapitulate. Americans don’t save enough. Americans walk away from financial responsibilities and in so doing jeopardized their country’s economic health. The IMF wants countries to de-insensitivize savings (by punishing banks with debt forgiveness plans) and wants less people to be financially responsible for their houses. Keynes’ legacy of moral hazard lives on and strong apparently. International economic institutions seem to be breeding ground for backward economic discourse nowadays . Kinda reminds me of this one trade theory teacher I had, who had worked at the WTO, and taught our class that China’s Renmimbi was significantly overvalued. not even a joke…. sad times eh?

Financial professionals joke about academics getting into teaching or researching because they weren’t smart enough to make it in the private sector. I’m gonna go out on a limb and believe that for now.

Best 30 Second Speech.

“Imagine life as a game in which you are juggling some five balls in the air. You name them – Work, Family, Health, Friends and Spirit and you’re keeping all of these in the air.

You will soon understand that work is a rubber ball. If you drop it, it will bounce back. But the other four balls – Family, Health, Friends and Spirit – are made of glass. If you drop one of these; they will be irrevocably scuffed, marked, nicked, damaged or even shattered. They will never be the same. You must understand that and strive for it.

Work efficiently during office hours and leave on time. Give the required time to your family, friends and have proper rest. Value has a value only if its value is valued.”

–Brian G. Dyson
President and CEO, Coca-Cola Enterprises during his speech at the Georgia Tech 172nd Commencement Address Sept. 6, 1996

Is the UN Marxist?

Dr. Flassbeck

I recently stumble upon an interview of Dr. Heiner Flassbeck the Director of  the United Nations Conference on Trade and Development’s department on Globalization and Development Strategies. In that interview he raised two points (at least in the first 5 minutes I forced myself to watch). The first one was that wages were broadly stagnant. The second point was that a struggle was occurring: not between north and south, not between developed and developing but between labor and capital! I’d first like to point out that he did not credit Marx with his assertion (plagiarizing a**). His ”refuses to die” idea was backed up with a chart of logged real wages and productivity from a speech given at the University of Berkeley by Damon Silvers. The chart showed that both variables tracked each other fairly precisely until the 1970’s at which point the growth trend of real wages unperformed that of productivity.

Now if we assume that the un-referenced data is correct and that by productivity it is implied labor productivity and that we are discussing about a chart describing the American labor situation, at face value it would seem that Dr. Flassbeck is right. But before throwing in the towel and replacing all our Bibles with Das Kapital (if you own a Bible), let’s examine the issue a little closer. Using a super standard macroeconomic growth model:

 where α and 1-α are the proportions of capital and labor respectively used to produce GDP (here Y) and with the entrepreneur/employer/firm/corporation/capitalist/slave driver trying to maximize profit through:

  we can derive what actually drives output growth per worker! It turns out it isn’t capital, it isn’t labor, it isn’t the choice of using one over the other it is… drum roll please… technology. So macro 101 tells us that productivity growth in the long run occurs because of improvements in technology. Even a business grad could have told you that. The crux of the problem however is that this very same econ 101 lesson would have told you that labor wage equals the productivity of that labor, like in the first 20 years of the chart.

Everything converges to trend eventually

The thing about this model is that it counts all labor as being the same. Try telling a German worker he’s the same as a Greek one. The real catalyst for the dichotomy resides in globalization, something Flassbeck seems to deny. If instead of calculating the productivity of labor  we calculate the productivity of capital we see that it is dependent on labor. A typewriter doesn’t write scripts without a writer. Let’s say as a publisher you can print 10,000 copies of a good book written by a French philosopher in the 18th century. Let’s say that suddenly an American writer comes along and is willing to be payed a quarter of the Frenchmen’s wage. While the French Voltaire still writes better books (is more productive) he has to convince you that your printing presses will make more money printing his book than say an increasingly popular Jefferson’s (increasingly productive). While for arguments sake the french 18th century writers are better than their american counterparts to not let the latter look like a good bargain the French will have to drop their wage demands. Similarly American workers need to start asking for less even if they are more productive than their Chinese rivals.

The reason for this is that we cannot look at the productivity of labor and wages in a closed circuit but rather in a World wide context. So while I’m sure the communist chart is correct in it’s assertion that industrialized wages aren’t keeping up with its equivalent productivity, I’m quite certain that on a global basis the gap between the real wage and labor productivity is shrinking. Just to be sure I’ll be crunching some numbers and getting back to you on this after exams.

Of Planes, Ships and Misleading

F-35 Joint Strike Fighter

Canada’s order with the Joint Strike Fighter program for 65 Lockheed Martin F-35 Lightning II fifth generation fighter jet will be the country’s second largest procurement of goods ever. The decision to explore replacement of Canada’s aging fleet of 79 CF-18 Hornets (of the original 138 purchased) was taken in 1997. Agreement to fund development of  a plane to serve NATO fleets was taken in 2001. In 2007 the participating countries agreed on Lockheed Martin’s design. While Canada has participated on the financial funding of the F-35 development and has signed memoranda of understanding on the purchase of the planes, the government hasn’t actually penned any deals as of yet. The official governmental decision to purchase the planes was taken in 2010. The Auditor General praisedthe Department of National Defence and Industry Canada for their cooperation on obtaining partial commitments for economic spinoffs (local procurement and parts supply). The praise was tantamount to a proud clap on the back for not having brought back Mulroney-esque graft to Canadian national procurement (hrum…hrum Airbus…Shreiber…hrumph). The AG’s report than proceeded to admonish those very same departments for having done a lax job of informing their overseers about the potential costs of the planes. The subplot: bureaucrats at DND and Industry Canada got a little over excited about the F-35s and jump the gun on the costing and decision of the purchase.

Michael Ferguson Auditor General of Canada

With this update readers might be made to believe that the furor and outrage afoot in Ottawa has to do with bureaucrats lying to duly elected officials and ministers. So how his it that Peter Mackay, minister of defence is public enemy number one? According to Ferguson at some point before the campaign the minister was made aware that the numbers he had previously been given were probably low-ball estimates. The minister chose to stick to the script and reiterate the one number he was sure of and for which written documentation was available. “A purchase tag price of 9 Billion dollars”. Now that number is not being disputed (the number was re-confirmed at a congressional hearing this past week in D.C.), what is being disputed however, is whether it was misleading. The purchase price does not include operating, maintenance cost, nor the estimated 15 or so planes that may be purchased for purposes of replacement. The full purchase and maintenance costs as estimated by DND in 2010,  up to 14-16 Billion, depending on the value of the Canadian currency. The life cycle costs estimated by the Parliamentary Budget Officer Kevin Page including purchase, maintenance and operating ran the 14-16 Billion tab up to approximately 25 Billion.

Kevin Page Parliamentary Budget Officer

Now these numbers are all more or less irrelevant. A plethora of external factors out of the governments control or the PBO’s capacity to predict will raise or even drop the final costing of the entire program. The facts are that there are two kinds of variables here (as always in economics) exogenous and endogenous, that is in and out of the hands of the government respectively. What should be obvious to any assiduous political commentator is that the Conservatives are getting pounded politically and in the media for their reporting or non-reporting of the factors which are out of their hands and for which no estimates can be reasonably assumed to be correct. But what of those factors who’s outcome can be – if not guaranteed – at least affected?

Leaving aside the actual question of the necessity of the jets’ purchase (this is a blog on economics not international relations/war), there remains some important questions concerning the JSF program. Often military contracts provide the political and nationalist cover military industrial lobbyists use to wash politicians memories of the basic laws of economics. For example, the AG report celebrates DND and Industry Canada’s efforts to wrestle F-35 parts supply contracts towards Canada. South of the 49th Congressmen exert pressure on Pentagon and industry officials to manufacture jets, tanks and ships in this or that Congressional district. Much ink is spilled over the astronomical costs of the F-35 in Canada but what of the largest procurement contract in Canadian history? Little or no attention is given to the 33 Billion dollars or so being spent on ship building in Nova Scotia and British Colombia. As almost all know, the geographies to which the contracts are allocated are for the most part chosen politically.

Peter Mackay Minister of Defence

A case can always be made for the necessity to protect national security and guarantee the reliability of military hardware. Everyone would recognize the stupidity of building NATO’s next fighter jets or tanks in China or Russia. However, when Canada awarded the shipbuilding contracts, one key requirement in the bidding was for Canadian content and jobs to be maximized. When South Korea, a NATO dependent ally, has some of the most cost efficient shipyards in the World why does the government not try to maximize the military bang for the taxpayers buck? How can the government accept to participate in the developing of the F-35 when it is de-facto an American controlled program. Why is it that the purchasing of military hardware must be operated through the Pentagon and not directly with the manufacturer? America’s NATO allies should demand an end to the discriminatory practices of the American industrial-military-complex. When it comes to that sticky number that is the cost of maintenance of the F-35’s, why is the government promising to do all the work in Canada. If the Canadian dollar is high the government should be sending the planes to the cheapest maintenance operations throughout NATO and inversely the debt plagued nations of NATO should send their repair work to the lowest bidder.

If the point of purchasing military equipment is to protect a nations sovereignty and citizens , why is it that countries are willing to trade more military capability for a few more jobs? Or in the case of the US get a lot more jobs but disproportionally more deficit and debt. If Italy is good at manufacturing and Australia is good at producing commodities both countries are poorer for trying to muscle in on the others specialty. At the end of the day military procurement is a game of intra-alliance attrition which makes us all that much poorer and less safe. Enough with the petty demagoguery of military jobs. If we really need strong armed forces to protect us let’s make sure servicemen are equipped with the best hardware and make sure our economies are competitive and strong enough to support those armed forces.

Could Carney Be Wrong

Mark Carney the Bank of Canada’s Governor has been one of the most vocal central bankers Canada has yet seen. He intervenes in the media often and repeatedly about some of his worries concerning the health of the Canadian economy. His chief worries revolve around three subjects broadly vassal to the theme of international competitiveness. The first of his worries is that Canadian manufacturers aren’t using the combination of low interest rates and high Canadian dollar to invest in cheap foreign capital goods. His second ”keep me up at night” issue is that of Canadian businesses’ low exposure to rapidly developing countries and over exposure to stagnant markets. His third problem and dilemma is that of rapidly escalating household debt load. While not explicitly saying so, Carney’s fear is that Canada will increasingly ressemble the pre-crisis US; a debt saddled and internationally uncompetitive economy. Commentators have been doing a fair bit of wall painting by noting that Canadian Households are second in indebtedness in the G7+BRIC category. Economic nationalists regularly plaster business newspapers with doomsday scenarios foreshadowed by Canada’s perennially lagging productivity. Alright, let’s breath… wait a minute and think about this.

It is a little funny that Carney’s most recent musings about Canadian manufacturers and business came less than a week after the latest numbers of the Canadian Survey of Business Investments . The survey’s data reveals that new capital expenditure (read fixed capital formation) is expected to run at the fourth highest clip in over two decades, only failing to surpass the dotcom bubble fueled investment mania at the turn of the millennium. One would have thought that the BoC Governor would have taken note of such a survey. It seems that manufacturers were just waiting for the Goldilocks’s moment of low interest rates, easy lending conditions and better international sales prospects to start investing. A traditional Canadian conservative way of doing business, one that served Canada’s financial sector well during the crisis. In any case with Chairmen Bernanke of the Fed’s pledge to keep interest rates near zero through 2014, Canadian manufacturers probably expect their low rates + high currency combo to persist a while longer, so what’s the big rush to invest? As noted above business investment isn’t our central bankers only preoccupation. Our aversion to developing nations export markets tick’s him off as well.

When it comes to Canadian exporters’ choice of export markets, I propose that bureaucrats who have never managed anything other than a hyped up economic think tank (say a central bank) or sovereign debt investment bank department (say at Goldman Sach’s), stay out of real businessmen’s head. When Mark Carney proposes exporters start doing business with emerging markets, which ones is he talking about? Is he talking about Russia? a country where ex-KGB mafia is indistinguishable from the oligarchical business class and where the contracts you sign are only as good as the prevailing mood of the Kremlin? Is he talking about Brazil? Brazil a country where if your company spills a drop of oil in the ocean your executives risk loosing their passports and being prosecuted by only thinly-veiled xenophobia infected local prosecutors. Maybe, he meant China? That very same country that will toss Rio Tinto executives in jail just to squeeze a better deal out of those executives’ native country and supposed business ally Australia. International business is a tough business in itself, why don’t we let those entrepreneurs that have first hand experience decide when they want to abandon the largest markets of the World (Japan, US and Europe) for some of the riskiest markets on Earth.

We’re left to examine the remaining entry on the Carney sin list. Our profligacy and lack of thriftiness. So Canadian household debt levels have jumped to never before seen heights. With interest rates at a historic low this is to be expected. The number however only gives an incomplete picture of Canadian households’ health. Household average debt says nothing about the distribution of that debt. In the US, the subprime crisis became a crisis because debtors were at or not far away from the bottom of the income distribution. In Canada most of the ongoing issuance of debt is for mortgages, and less than 9% of Canadians have less than 10% equity in their homes. If we add the two together it says that on average wealthy Canadians are the one’s increasing their average debt load, since homeowners that own a decent amount of home equity are generally well off. Something which makes sense as most wealthy Canadians do not need to indebt themselves to live, whether they choose to invest when their financing costs go through the floor is a whole other ball game. Maybe commentators want to come out with more data on the distribution of indebtedness in Canada before alarming national rate strategist.

The accusation that Canada is uncompetitive however is rooted in other numbers than simply those on indebtedness or exposure to this or that foreign market; it is rooted in the fact that on an aggregate level more Canadian workers working longer hours have not been producing as much. The US has seen its per worker productivity increase faster than Canada’s for much of the last few decades. Something that we should all be worried about in normal circumstances. Canada is not living in normal circumstances. Canada is in the midst of reallocating some of its labour and capital resources to a sector where it actually holds a comparative advantage. For the last few years Canada’s workers, corporations, entrepreneurs and capital markets have been investing time and effort in developing its valuable natural resources. There are very long lags between payoff and investment for some of Canada largest most capital intensive projects. The Business Investment Survey forecasts fixed capital formation in the resource extraction industries will beat the record set last year by $13 Billion dollars. For now this money creates little revenue, profits or exports but 3, 5, 10 years down the line expect to see GDP jump. Building Oil Sands steam assisted gravity drainage mines takes years, likewise BHP Billiton’s Jansen potash mine wont be operational for years. The Canadian mining landscape is only now starting to bubble, when it starts to boil those productivity numbers we spend so much time worrying about will become jokes. All in all Canada is shifting. The economic landscape we now see will not be the same. Mr Carney rest easy, Canada’s households and entrepreneurs have got this one under control.