Fiscal Fear Mongering in Quebec or Separatist Number’s Lunacy?

Independent Quebec’s greatest economist or numbers’ charlatan

Earlier this month Ed Devlin the head of Canadian portfolio management at Pacific Investment Management Company warned Quebec politicians to be careful in the upcoming elections. Devlin an expert in fixed income market and liability-driven investing wrote a research note¹ on Quebec’s debt dynamics and the possibility that talk of sovereignty had the potential to derail the province’s current virtuous debt dynamics as has been the case in parts of Europe in the last few years, most notably Italy.

The research note sparked indignation in French language media and in separatist circles. PQ economic critic Nicholas Marceau was ‘shocked’ by the scare tactics employed by Devlin and Martin Aussant head of the party Option National, an ex-economist himself, stated that the head of PIMCO Canada’s analysis wasn’t credible. Even the federalist Parti Liberal du Quebec felt the need to chip in, with finance Minister Raymond Bachand saying that Quebec and Italy were not comparable as they were not in the same ballpark.

It would seem that the lively reactions from the political sphere have proved Devlin right, Quebec politicians just don’t get it. The Liberals and the Option National seem to agree, Italy and Quebec cannot be compared. Martin Aussant actually went on record saying that Quebec was in the average of OECD debt to gross domestic product (GDP) percentages. The question now is whether Aussant wants to plead guilty to ignorance or deceit has he is wrong about Quebec’s relative average debt load.

If one were to take Quebec’s provincial ‘net debt’, which measures the provincial government’s debts minus the province’s assets, Aussant would be right, Quebec is just slightly below average in terms of debt to the size of the economy with a debt of 47% in 2010 versus 56% on average in the OECD. The conversation might have stopped there if Aussant had done his economic homework, but having been in politics for much too long it would seem that his professional due diligence might have slipped a little. Quebec’s net debt measure doesn’t use the same methodology as the OECD, one would have to add all provincially guaranteed debts to the equation to properly compare with the OECD’s numbers.

Thankfully the provincial Auditor General wrote a 2010 study attempting the exercise of comparison. He came up with another net debt number 53% of GDP. While this number is higher it remains squarely in the OECD average, this was surely the number that separatists like Aussant think about when talking debt dynamics. However it still isn’t the same number the OECD uses. The OECD calculates total debts not net debts. Using that number Quebec jumps straight to the top and comes in just shy of the podium in fifth place of most indebted jurisdictions in the OECD. Not really close to the average as certain like to claim.

But all this fails to take into account that separatist want to separate from Canada, hence the Canadian debt proportion that an independent Quebec would certainly have to assume. Adding today’s Quebec gross debt to its proportional share of the federal debt, an independent central Quebec government would have a whopping debt load of 135%. There you have it folks Quebec would take the bronze medal for national debts if independent, right behind gold winning dysfunctional Japan and bankrupt and bailed out Olympian Greece with silver.

Some might ask how is it that Quebec can be one of the most indebted jurisdictions in the world and not go bankrupt, while even the United States is quietly considering² State bankruptcy legislation for its lesser indebted local jurisdictions. The answer is hotly debated in Europe right now, and was correctly pointed out by Devlin in his research paper. Europe and even the US to a lesser extent are monetary unions without fiscal unions; they share currencies without sharing fiscal resources much to the contrary of the Canadian federation.

Through the equalization formula Quebec receives a fiscal top up (worth over 10% of its provincial budget), effectively buffering it against the reckoning of financial markets. While Europe dithers on the question of bailing out its member States, every year ‘have-not’ provinces get a mini bailout. Without assurances that this money stream is permanent international investors would drop Quebec debt securities so fast Spaniards would thank financial markets for having gone easy on them.

Another rationalization separatist economists like to use to explain why Quebec is much stronger than the rest of the worlds is that when looking at net debts Quebec’s finances are resilient. That could be true if there actually were assurances that those assets that can be sold off to pay debts were worth what Quebec’s balance sheet says they’re worth. Unfortunately, that never seems to be the case. Just before Iceland got into trouble and got bailed out by the IMF it had one of those on paper fortress like balance sheets. It actually had a much lower net debt ration than Quebec does today. Unfortunately when a country gets hit by a deep recession, increasingly likely nowadays, asset values tend to drop and net debt ratios tend to shoot up. Since the Caisse de Depot et Placement du Quebec (a huge chunk of Quebec’s assets) has already proved it’s capable of loosing 40 billion dollars in a single year, what assurances remain that those losses won’t repeat themselves. And If Quebec were to separate who exactly would like to swoop in and buy Quebec’s crown corporations? Greece has been selling its State owned enterprises for pennies on the dollar in its crisis, what assurances are there that Quebec’s assets will sell for much more? Using accounting valuation to describe the worth of a government’s assets is quite the precarious game and it takes a lot of optimism to believe those numbers as credible.

Another favourite retort against Devlin’s research note is that Quebec doesn’t have the fiscal evasion problems that Italy and its ilk have. While this is true, Quebec has a much lower proportion of taxable wealthy citizens than Italy does. Given wealthy anglos historical propensity to leave in times of separatist pressures, the issue in Quebec shouldn’t be whether we have a tax evasion issue come separation but rather will Quebec have a wealth migration issue if that time comes. All in all separatists may continue to find tricky accounting techniques to rationalize separation economically, but at the end of the day numbers and facts can only lie so much. The separatist project remains far from credible economically.

If separatist political parties want to head out the door of Confederation giving up equalization payments and accepting a whopping debt bill on the way out of the restaurant maybe a little more fear mongering is in order. Let’s hope that cooler heads prevail in this election campaign and that market rattling talk of separation can go back to were it’s been hiding for the past two decades: the dust bin.

US still Wealthier than Canada

The commentary and Op-Ed spheres are a flutter with talk of Canada having finally surpassed Americans in wealth. The assertion stems from a report by the Toronto based Environics Institute. In its report Environics highlights the average net worth of Canadians and Americans and how Canadians have surpassed Americans in that respect since 2006. The report was than picked up by a plethora of commentators ranging from Jonathan Kay at the National Post and Stephen March at Bloomberg all jumping on the bandwagon calling Canada’s socialism lite version a success relative to America’s capitalism.

 It is being said from all quarters that the Canadian economic tortoise has passed the American economic hare.

While it is heartening to see that Canadians are wealthier than Americans by this measure, the unbridled optimism of the Left needs little reality check. First the numbers they use need some context. The traditional measure of wealth, especially for Keynesians, has always been consumption, or consumption power. By this measure Americans remain much wealthier than Canadians. The Environics report itself states that disposable income (after tax pay) remains much higher in the US than in Canada by a staggering 67%.

Now many would argue, and rightfully so, that after tax income is a poor number for comparison as Canadians live in a country where they receive much more government provided services, not counted in the disposable income number. Turning to the Purchasing Power Parity adjusted GDP per capita number, we get a clearer idea of how many goods and services, public and private, that both countries’ citizens get to enjoy. In Canada that number is of 38,988.94 US dollars as of 2010 by the World Bank’s count. The equivalent number in the US is of 47,198.50 for the same year. That means that counting all goods and services consumed by citizens and adjusted for monetary discrepancies, Americans remain a full 21% richer than we are.

So why does the net wealth number paint a different story than the consumption numbers? The reasons are many but important. The first reason is that the US is in the bottom of a business cycle. After a good few years of growth the American economy is adjusting and correcting a few accumulated imbalances in its economy. Canada on the flip side is not. While we did suffer a mild recession, by no means can it be said that Canada is at the bottom of the business cycle.

While GDP did contract and unemployment did rise in Canada, house prices haven’t contracted at a faster rate than inflation since 1990-1991. The pace at which Canadian housing has grown in the past decade or so, would seem to indicate the Canadian tortoise has grown some long legs and bunny ears. The point is comparing two nations relative wealths at different points in their cycles obscures the long term trends in relative wealth. When Canada’s debt bubble rears its head and interest rates creep up do not expect housing prices to continue in their current upward trajectory. With a correction already in the bank expect American house prices to do some serious catch up (albeit probably slowly at first). With Housing values being literally the only variable where Canadians win in this equation, odds are the current crown on our heads is sure to be a temporary footnote in economic history.

While the likelihood of Americans reclaiming their North American wealth crown within the near future seems all to real, this should not distract us from looking to the future with confidence. Some of the long-term trends that have been developing for years now point to the real chance that Canada may yet come on top one day.

The Oil Sands will provide abundant resource to Canada for the next couple of generations, so the possibility of investing those gains efficiently and fiscally responsibly might yet lead to sustainable wealth which we’ll then be able to boast about.

British-Columbians Without Leadership on Northern Gateway

There used to be an unwritten golden rule for Provinces in Canadian politics; if you are going to do some beggar thy neighbour monetary demanding or demonizing make sure it’s against the feds. Provinces typically demand funds from flush federal government coffers, or when they need a scapegoat for this or that local problem they can always trash the federal government for their ills. They usually abide by a set of rules of solidarity to put pressure on Canadian federal governments. With Stephen Harper immovably tightening the federal purse’s strings, it would seem that hard-pressed Premiers need new scapegoats for populist speeches and monetary extortions.

 This new reality was on full display this week as British-Columbia’s Liberal Premier Christy Clark put down her conditions for the approval of Enbridge’s Northern Gateway oil pipeline joining Bruderheim, Alt and Kitimat in BC. Clark put down five conditions for her approval of the project the most important of which were world-class environmental emergency response plans, for Enbridge to go beyond the minimum legal requirements with respect to First Nations relations and for BC to get its ‘fair share’ of tax revenue from the oil to flow through Northern Gateway.

 The Premier from Alberta Alison Redford responded to Christy Clark today by saying that BC won’t get a looney’s worth of tax money it is not already entitled to from the pipeline. Stating that resource management is the purview of individual Provinces exclusively, Ms. Redford objected to Ms. Clark’s policy of nitpicking projects and subjecting them to targeted political scrutiny.

 Ms. Clark’s approach to Northern Gateway however deserves much more scrutiny than Alberta’s Premier has so far leveled against it. Let us start by examining BC’s request for world-class environmental disaster response plans. That such regulation wasn’t already the norm in BC should be news to British-Columbians. Since environmental regulation is as much a provincial responsibility as a federal one, why is BC home of Canada’s most ardent environmentalists not already the most protected and best regulated in the world? Does this mean that other energy projects aren’t going to be subject to such environmental scrutiny? Why single out Enbridge when it comes to protecting Canada’s Pacific coast?

 Moving on to the provincial Liberals’ demand that Enbridge go above and beyond legal requirements in dealing with First Nations. Enbridge states that it already has 60% of concerned Native bands signed on to Northern Gateway. If so many First Nation’s have already of their own volition accepted Enbridge’s proposals one might assume that the company has already gone beyond legal requires in enrolling Native support. Why go into the media playing the ‘white man guilt’ card against Enbridge? This looks like an almost Orwellian display of government interference in private affairs. Governments should not ever, be in the business of telling private citizens or corporations how they should think and behave. Ms Clark shames the name of her party with such private affairs meddling.

 That Ms Clark should go after private enterprises in trying to boost her pre-electoral profile seems to fit with the times but for her to go after another Province for revenue is a relatively new development in Canadian political history. Ms Clark has asked for a ‘fair share’ of tax revenue from Alberta.

 A report by Calgary firm Wright Mansell estimated that BC would only be getting a paltry 6.7 billion dollars worth of tax revenue from the pipeline over 30 years from a total pie of 80 billion. Ms Clark pointed out that BC would be shouldering 100% of the maritime environmental risks and over 50% of the land based risk. With such false assertion the BC Premier is effectively spitting in Albertans and Canadians faces. The environmental risks don’t start at Bruderheim, they start near Athabasca Lake where the extraction occurs and where Alberta will cover 100% of the risk. Let’s face it, the oil sands represent the largest oil related environmental risk worth monitoring, Northern Gateway is a sideshow. The oil must flow through pipelines all the way down to Bruderheim first where again Alberta is responsible for all leak risks. In any case the monetary responsibility of cleanup falls squarely on Enbridge so what kind of risk is the Province assuming exactly? With proper regulation, which BC is entitled to implement, risks can be minimized if not eradicated so why demonize Alberta?

 Ms Clark further added injury to insult when she said, “This project is good for Canada. It’s great for Alberta and at the moment it’s not very good for British Columbia”. It would seem that 60% of concerned First Nations disagree. Such blatant ‘not in my backyard’ styled blackmail is unbecoming of a Canadian Premier. What would Canada look like today if it weren’t for generations of Ontarian and now Albertan uncompromising funding of equalization? Such inter-provincial self-centeredness hasn’t been seen since the Lower Churchill Falls deal where Quebec unceremoniously screwed over Newfoundlanders.

 If political leadership is bringing out the best out of one’s constituents, BC’s Liberals have succeeded in wrestling the crown of leadership deficiency from Quebec. It was bad enough when Obama blocked Keystone XL for electoral purposes to the detriment of America’s economy and North American relations, that such demagoguery and populism should have crossed the 49^th parallel is a new low in the history Canadian Confederation.

(First published on The Prince Arthur Herald website)

***Apologies to all readers, this post has somewhat strayed from the more economic level headed commenting this blog was started for. None the less this was worth posting enjoy.

The OECD Has it All Wrong About Canada

The OECD came out with its Economic Survey of Canada last week and like so many other institutions and commentators before it, has got it all wrong. The report lauded Canada for its fiscal performance but gave it a failing grade for productivity growth. The report, amongst other things, criticizes Canada for its declining multifactor productivity, a measure of output denominated by an assortment of production inputs. The report asserts that multi factor productivity (MFP) has been declining since 2002 and seriously lagging that of the United States. The report adds that Canada’s factors of production mix is skewed heavily towards engineering structures to the detriment of machinery and equipement.

While MFP has been dropping in Canada since 2002, many would argue that looking at labour productivity is more important. Productivity per hour worked in Canada has grown from $156 to $183 from 1997 to 2011 an increase of 17% over the period, far from the alarming trend the OECD reports. Noteworthy however is the slowing growth of productivity growth during this period from a high of 2.61% in 1999 to the present growth of 0.75% in 2011

The error of the OECD report however is one of not looking into the underlying trends and the break down of productivity change by industry. If one breaks down the numbers to find out which industries contributed to the change in the overall economy a few truths become apparent. The slowing growth is mostly attributable to one sector: mining and oil & gas extraction. This sector registered the steepest loss in productivity since 1997 contributing -8.17% to overall per worker productivity in Canada. Virtually all other sectors contributed positively to productivity growth (with the exception of the public sector and its tangents). And since mining and oil & gas extraction is the fastest growing sector in Canada the loss in productivity weights down heavily on the numbers reported by the OECD.

MFP is weighted down even more heavily by the this sector, as much of new fixed capital formation originates from Alberta’s energy industry. So why isn’t this trend worrying? the answer lies in the basics of economics. Productivity in tangible assets tends to lagg investment by tangible assets. Basic macroeconomic models tend to assume a lagg of one year between investment in fixed assets and new production from those assets. But the oil sands development in Alberta is bucking that trend as the magnitude of those  investments is larger than ever before, and the huge oil sands mines of the Athabasca region are unparalleled in history.

Most of the mines under construction take between 5 and 10 years to reach capacity and since the oil sands developments are still relatively new, few if any of the largest mines are near capacity. Production in the oil sands is estimated to double within the next decade while employment will drop as temporary construction jobs in the sector are slated to be replaced by fewer permanent operating jobs.

These trends will lead to a complete reversal of the national productivity contribution of the sector, from the most negative to what will be the most positive contribution. Canada’s over investment in Engineering structures isn’t a fluke accident on the part of Canadian businesses. It is rather a sign that business leaders in the nation understand where Canada’s growth will come from in the future.

What is strange is that these developments are widely known, as the Canadian Association of Petroleum Producers widely communicates them. That the OECD and the Bank of Canada before it, have not picked up on these trends is testament to the short term vision of macroeconomic study at some of the most important economic institutions. One hopes that policy makers don’t get wound up in the noise from these economist and continue to provide policy changes geared towards letting Canada shift economic activity to where the nation has a comparative advantage.

Krugman Baltic Bashing 2.0

It would seem that after a tweeter row with Estonian President, Krugman hasn’t had enough fun senselessly putting down Baltic States. In his new blog post, Krugman turns against Latvia in his anti-austerity tirades. While he initially criticized pro-austerity commentators for ‘lionizing’ Estonia as a standard bearer for successful austerity policies, he know seems to believe that Latvia was the lionized example for austerity. Leaving aside Krugman’s inability to decide which austerity policy orientated government is easiest to criticize let’s take a closer look at his accusations.

Krugman quotes Eurostat numbers for real GDP levels, showing that Latvia has had the deepest contraction of the Baltic States, Ireland and Iceland, also showing Latvia having the smallest recovery of pre-crisis level GDP. A few notes must be added to his demonstration. Firstly, both Ireland and Iceland received EU/IMF bailouts to stabilize GDP and also e currency’s value in Iceland’s case, none of the Baltic States received such external inflow of capital to buttress government spending.

Furthermore, both Latvia and Lithuania racked in relatively big budget deficits during the crisis in comparison to Estonia. Why attack the Baltics states least keen on austerity for their austerity policies, why stop talking about Estonia, the real standard bearer for fiscal hawkishness. Again leaving aside this Krugmanesque inconsistency let us look at Baltic States in Comparison to other Euro economies many of which signed on to the G20 pledge for stimulus spending during the crisis.

 Here, seasonably and daily adjusted quarterly per capita real GDP numbers from Eurostat (same source as P. Krugman) tell a different story. This chart shows that while the recession was deep in the Baltic States the recovery was strong, leading all Baltic Nations to have caught to their pre crisis levels (per capita of course) and to the EU as a whole. While Germany, arguably the strongest economy in Europe is above its pre crisis level, there should be no denying that the Ba;tic States chose to bite the bullet early but recover quickly. One wonders if so much can be said for the PIIGS. So without a European bailout Latvia and its Baltic colleagues don’t seem to be doing all that bad. As has been argued before Krugman fails to take into consideration decline population into his thinking when using national GDP numbers. A guess can also be ventured that depending on what time series he chooses to use (constant vs market prices) numbers may vary substantially when evaluating economic performance, no nuancing words from him on that subject.

In any case to better understand recovery dynamics between nations attention must be paid to the depth of contraction as well as the magnitude of recovery. The above chart shows the ratio of real per capita GDP recovery to real per capita GDP contraction. With an EU average a smudge over 1, one can see that the strength of the recovery has been stronger in the Baltic States than in most of Europe. Only the Norther nations of Germany, Austria, Finland, Luxembourg and a few others have been stronger.

So how to explain the difference between austerity in the south and in the Baltic region. The most obvious answer is that states that don’t rely heavily on Government spending during the good times stand to loose less from tight fiscal policy in the bad times. Ireland and Spain do of course buck that trend but the conjecture of their recessions were different in nature than in most of Europe. 

Again it must be repeated that much of the superficial weakness in the Baltic States must be attributed to Europe in general and the rest of the sluggish growth in the World. As export dependent nations they should not be expected to outgrow other regions when there is only week growth in consumption outside their borders. There is however much hope for the Baltic tigers future prospects. As export dependent nations who have refused to transition to internal consumption driven economies, they remain leveraged to an eventual uptick in World growth and are less dependent on foreign capital flows to pay for their growth.

Small open economies the World over should learn from the Baltic experiment that is unfolding and look forward to the next chapter that will surely put stubbornly uncompetitive economies to shame. Let’s hope Krugman can remember his own writings when that happens, so that the rest of us can enjoy his efforts at keeping a straight face when attempting to convince us he was right all along.

PPP New Conduits for African Development?

Montreal. One of the conferences at the Montreal World Economic Forum of the Americas centered around African nations’ experiences with Public Private Partnerships. The handful of African ministerial aides indulged in a fair bit of finger wagging and corporate bashing. While the rhetoric was moderate, the systemic deficiencies in the African growth model were made clear.

What was made clear is that the avenues through which African ministries and international development agencies attempt to alleviate poverty have skewed the incentives for long term growth of the continent. The discussion at hand were centered around the 3P model of development and the various benefits and shortfalls the projects have represented in the past. Surprisingly little discussion was expanded around the subject of 3P structuring.

3P projects seem to have gained a certain amount of popularity in Africa of late, as financing infrastructure projects of quality remains a challenge for the revenue challenged nations of Africa. Inviting corporations to come finance and operate governmental pet projects has become the priorité du jour, with the stated objective of reducing poverty. Some may ask how effective this top down setup really is.

On panelist from the African Development Bank raised the question of best practices for handling unsolicited private sector proposals for 3P projects, while another raised the issue of setting up a strong and consistent framework around 3P structuring. The issue with government developing and choosing infrastructure projects is obviously one of pork barrel economics. Especially in a continent such as Africa, the process should be as arm-length away from the political, what better way to do that than to let the private sector originate 3P project ideas. The potential innovations and efficiencies of private sector involvement would be compounded and government exposure to risk, that a project might loose taxpayer money, would be reduced since the profit motive would guide all project initiations.

For businesses to be permitted to propose 3P projects the guidelines and norms regulating ownership and revenue sharing would have to be determined ex-ante and implemented consistently. This would enhance trust, reduce risk both for government and business and especially enhance the likelihood that only the most pressingly necessary projects get built.

That no one in the continent hasn’t yet put the two ideas together and implemented them, speaks to the continents disfunction and lack governmental vision and innovation. Further discussions with the African Development Bank reveals that few international institutions have the mandate or the clout to suggest frameworks for developing mutually beneficial 3P frameworks, 3P’s are unlikely to be the panacea for growth hoped for. The continent will have to continue bitting its time waiting for someone to finally push through the growth policies the African continent desperately needs.

Dairy Farmers or Wolves in Cow’s Clothing

FDR used to say that the American farmer was the backbone of America. Likewise in many European countries the agricultural lifestyle is considered like a cultural legacy worth protecting. Canada has not escaped this neurotic infatuation with farmers. One needs to look no further than the advertising campaigns by Quebec dairy farmers to get an idea of how important to society they believe themselves to be. In Canada a more governmentally coddled group of individuals cannot be found, nor a less politically bullying. Ever heard of a politician getting elected on a promise to tamper with Canada’s agricultural supply management schemes? didn’t think so. In Canada to produce milk one needs to purchase a milk production quota. A quota cost $25,000 dollars in Ontario giving the average dairy farm owner millionaire status based on the sole value of his quotas.

Réjean Ouimet, a general manager at St Albert Cheese in Ontario, believes that the dairy supply management is the “best thing in Canada”. “For a small co-op it makes life a lot easier, as we don’t have to deal directly with producers, worry about transportation or even quality control standards on farms.” That is reassuring. Essentially supply management makes dairy farmers lives easier. They don’t have to compete with each other, they don’t have to compete with imports too much (given tariffs on imports rising above 300% in certain cases), they don’t have to do anything but push a button or two and voila milk is arrived. Obviously their jobs are more complicated than that but their own testimony seems to imply their jobs could not be easier under any other system. So great, the then thousand or so dairy farm owners of Canada are richer, live easier lives than they would have in a free market but at what cost?

The first to be punished by the system are actually dairy farmers themselves, or at least prospective dairy farmers. On top of buying installation, cows, equipment, land and developing relations with processors dairy farmer wannabes must purchase onerously expensive quotas to start up a farm. Forget about innovation in an industry where the middle finger is flown at the face of all prospective entrepreneurs.

The second group of people to be punished are the consumers and not just in one way but indeed twice over. Firstly they must compose with higher prices. Some will argue that the benefit of high prices is less volatility in those prices, one wonders what your average motorist would say if he was to be guaranteed a litre of gas for his car at  $2 as opposed to a price that fluctuates between $1.25 – $1.50 ? He would be outraged and so should milk drinkers. The second manner in which consumers are miffed is in terms of choice and quality. With import duties being as high as 300% on certain cheeses good luck finding cheeses half the quality as in France at anything under twice the price. While it must be admit that certain cheeses from Quebec are quite good, that should bolster the case for free trade as local fromageries could then surely compete against imports.

While the above arguments are traditional when it comes to discussing the disadvantages of restrictive trade policy their is a much more pernicious cost imposed on Canada because of supply management and that cost is diplomatic. It is virtually universally accepted in Canada that NAFTA was a resounding success. Since then Free Trade Agreement negotiation has become something of a political sport. Canada is already on the road to becoming the first nation to have FTA’s with three of the World’s four greatest economies (US, Japan, European Union). Virtually all economists (outside of academically backward countries like France et al.) agree that untampered and reciprocal free trade is in everyone’s benefit. Canada’s dairy farmers are vehemently against FTA’s that imperils their economic rentiers status. Canada has already been shut out of the Trans Pacific Partnership groupe of free trade negotiating countries on the basis of supply management. How many more FTA’s do Canadians want to deprive themselves of to protect the wealth of a small group of individuals?

Why should Canada have more rather than less dairy farmers. Their is an almost perfect negative correlation between per capita wealth and share of population in agriculture, which means the less agrarian a society is the more wealthy it is. Do Canadians really want to be less wealthy? In any case for those farmers afraid of loosing their livelihoods to a liberalized dairy product market, they can be pointed to New Zealand as an example which became a World leader in dairy product exports, since abandonnement of its supply management schemes decades ago! Few industries hurt Canada as much as dairy farming, it’s time Canadian politicians stopped kissing their butts and started kicking them instead.

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.

“Francois Hollande” or “Homo Economicus Has Left the Room”

Many people may be forgiven for forgetting that France is one of the Worlds great nations. Let’s gloss over some of France’s economic credentials. Fifth largest nominal GDP, ninth largest in PPP adjusted terms and second largest economy in the European Union. Fifth largest exporter in the World, with over half a trillion of exports annually. Member of the G8 countries, G20 group, OECD, third highest military spending in the World and second largest gross foreign aid provider. Needless to say this stature and success has arisen because of the hard work, industriousness, and entrepreneurial spirit of the French people. The French people while reveling in their stature externally are much more cynical about their successes at home. Most Frenchmen speak of the “Glorious Thirty” and the “Pitiful Thirty” years, eras of post-war economic boom and subsequent economic stagnant malaise. Much attention and commentary is dedicated in political and intellectual circles to restoring the lost equilibrium of previous times of plenty. Much media analysis revolves around the stagnant fortunes of the French way of life and the middle class’ dwindling standard of living.

The French are also quite the political people. A country were successive constitutions have put the onus of wealth creation on governments and on individuals but only through their political choices. France thus, has seen successive ideologies and political currents wrestle with the central question of balancing collective wealth and well being with that of the individual. One might assume that through its rich political and governmental experiences certain lessons of history might have been learned. Moreover, the French being great internationalists and multilateralists, one might further assume that the country strives to benefit from the experience of its fellow nations with regard to its great equity dilemma. One would, seemingly, be wrong to assume these things. The popularity of France’s current presidential candidate front-runner would leave any Homo economicus perplexed.

The first big splash by the ‘Parti Socialiste’ presidential candidate came when he announced on live television that he wanted to impose a 75% top marginal income tax rate for revenues over a million euros. Other policies announced supposed to reduce ‘inequality’ were; a maximum lowest paid worker to CEO salary ratio of 1 to 20 and a new tax bracket from 150 000 euros to 1 000 000 at a higher 45% marginal rate (currently standing at ~41%). In Hollande’s campaign platform other musings are added to the effect of reducing income tax deductibles for the wealthy. Now, what might be the effect of such policies? (aside from giving Swiss bankers a collective orgasm). One effect would be to vilify the wealthy, to the point where many might leave, if not most. Since most wealthy people (first generation at least) are entrepreneurial and industrious business builders, maybe the intention is to reduce wealth and job creation? One French daily has aptly called the phenomenon of geographical tax jurisdiction arbitrage “Fiscal Exodus”. If the Laffer curve central thesis remains correct, all other things equal, the number of wealthy Frenchmen in Brussels, Geneva and London may well continue to swell.

Ultimately these measures are only for show. They only serve the populist and demagogic purpose of insuring the poor and disenfranchised vote with the socialist. A Hollande aide confessed that the measure might only bring in 250 million extra euros to the treasury, a paltry sum compared to the economic damages the policies will wrought. A policy that is sure to impact the treasury much more severely will be the promise to return the minimum legally insured retirement age back to 60 years of age. The present right of center French administration pushed through an increase in the minimum legally guaranteed retirement age to 62 from sixty back in 2010. The measure was put into place to more or less avoid a Greek fiscal fiasco when baby boomers begin to retire ‘en masse’. Francois Hollande plans to jettison that law, because he believes, apparently, that for every 2 years worked in one’s life, one deserves a year of retirement on average. Add on to that policy his intention to re-tinker the corporate tax rate (35% for large co.’s and as low as 15% for very small enterprises) this would cement France’s third place in the highest corporate tax rates for industrialized nations category. Combine the fact that progressiveness in corporate tax rates is just an incentive for small corporations to generate a maximum of dividend by not reinvesting profits into growth and the fact those marginal rates are going up and it would seem the French Socialist Party is on a war against international competitiveness!

While the above policies don’t really hold up to current economic thought standards, they can be forgiven as staples of the Left’s campaigning and showmanship. The policies that really drive me up the wall are Hollande’s policies towards the Euro. The first policy is one of negotiating a new fiscal treaty where Euro bonds would be issued. With benchmark French 10 year bonds yielding over 90 basis points over similar maturity German Bunds, the trans-Rhine cash grab is barely veiled. No wonder Angela Merkel does not want to meet her greedy potential counterpart. The second Euro Zone focused policy is even more morally hazardous than the first. The socialist candidate wants the ECB to adopt a dual mandate of inflation targeting and growth promotion. Never mind the moral hazard of bailing out broke Euro members, has nobody in the socialist party opened a Monetary Policy introductory book in the last 20 years? Since the early 1990’s central bank after central bank have shifted their monetary policy objectives from currency targeting and growth maximization to inflation targeting with invariably positive results. For a leading candidate to the highest public office of one the greatest nations of the World, to have such a crass and laymen understanding of fundamental economics is astounding to say the least.

So, while arguably the most archaic central bank of them all (the Fed) moves towards greater transparency and is subtly shifting its policy onus from a balance between inflation and growth towards inflation targeting, the French socialists want the ECB to move 20 years backward and forsake its stellar inflation record. Hollande could just as well shout out “To hell with responsibility and orthodoxy”. So let us recap. While the American Left embodied by the democrats and President Obama talk of lowering corporate taxes (to 28% at last check) and encourage the Fed to be more contemporary, the French Left embodied by Hollande wants to turn back the clock of time to a time were symbolism and intentions matter more than results, where its central bank would be ‘nicer’ to poor countries and its corporate tax rate would be higher. Let’s hope that sober economic thought prevails at the end of this campaign, because so far it’s only been mired in intellectual mediocrity. France has always wanted to go against the grain of conformity, who would have know that being conform even in success was so distasteful.

Shout out to our Ghanaian readers!

Cius

Bretton Woods Stress Disorder Again?

Did you hear? China is manipulating its currency to enrich itself on America’s back. Were you not aware that the Euro was actually German machinations so that it could out-compete the area’s periphery for its own gain?

There is a lot of talk out there of currencies being used as a form of weapon in the 21st century’s new form of favourite international warfare; economic warfare. Everybody seems to be guilty of partaking in this ‘non-violent’ form of confrontation. China has an undervalued currency pegged on the US dollar. To be fair, over a dozen other countries do too. Half of western African countries have pegged to the Euro as well as a few notable others. Accusations have been leveled against Germany for unduly profiting from the competitive weakness of its monetary partners since the 1992 Maastricht Treaty (and especially since the Euro crisis of 2011). Various central bankers and government officials around the World have called quantitative easing intentional currency manipulation, essentially accusing the US of cheating (the Bank of England and European Central Bank would also be guilty of this in such a framework). Essentially there has been a lot of posturing and indignation flying around focused on this one issue of currencies. I think remembering what a currency really does for an economy could help cool the air.

Some people like to say that currencies function as market mechanisms. Now nothing could be further from the truth. Just because there is a semi-unregulated currency market does not mean currencies are free market instruments. Just like a carbon market is not a liberal concept because trading is free. The collapse of the Bretton Woods system occurred because nations couldn’t compete in a relatively free trade environment. Certain nations were more competitive and the others did not have the political will to increase national competitiveness. A new system arose quite naturally whereby a floating currency did all the work of correcting competitive imbalances. As a nation comparatively slid into economic incompetitiveness its currency would be reevaluated downwards by a free currency market to insure a semblance of equilibrium of balance in trade terms. Essentially governments outsourced the responsibility of putting into place national competitiveness to the markets to avoid labour disputes and imposing fiscal rectitude to national budgets.

So when China pegs its currency to the US’s it is in fact just returning to a Bretton Woods type formula. If a trade balance exists between the two countries it is because the two governments do not share the same appreciation for macroeconomic rectitude. While the US splurges as a nation China saves. While in the US labour movements have the legal upper hand on business (see GM, Chrysler bankruptcies and Boing labour conflicts) in China pro business policies abound (sort of). In essence, the Chinese government does not shy away from imposing strict macro prudential policies on its economy, America elects Democrats instead. So the US’s complaint really resides in its political dithering with regards to economic policy. China’s currency policy is just one of limiting the risk to business of currency volatility. A policy US corporations should be in total agreement with if unclouded by nationalistic sentiment. To sum up a free floating currency is just a political tool to avoid hard decisions domestically.

Let’s remind ourselves of the cost of a free floating currency when a country is profoundly uncompetitive like Greece and even the US. When a country runs successive and deep current account deficits it means the country is chronically living above its means. A free floating currency would drop to correct this phenomenon. Increasing the price of foreign goods to impose a contraction in national living standards. So a country would in theory spend less on imported goods (food, clothing, cars and other discretionary items) to afford overspending in other goods (typically healthcare, education and other entitlements). So next time you see your native currency drop, odds are good that to afford government social programs you and all other individuals will need to buy cheaper food, flimsier cars and smaller houses. I wonder if electors aware of these dynamics would so liberally demand government services if they understood it meant less beer Friday night and less outings to the restaurant. Now some social democrats might argue it’s the price to pay for equity. Remind the next one you see that poor people are disproportionately affected by increased inflation on consumption goods. If they think value added retail taxes are regressive tell them government services induced current account deficits are more so (lost jobs, lost buying power).

So if one believes the Chinese won’t give up the peg and the Euro will survive (both highly likely outcomes) another solution is necessary. The US to take as an example, are doubly guilty of digging there own grave. The US worker remains the most productive of the World by any metric, so why does does the Chinese worker out-compete him (as demonstrated by the gaping trade deficit between the two countries). The reason is because the Americans are doubly competitive. How so? One of the US’s greatest exports with which virtually no country can compete is its government debts! No other financial instrument is more prized than the US’s Treasury Bonds. While the merchandise and trade balances can be negative the balance of payments always equals zero.

So all countries are faced with a straightforward choice; export goods and services or export financial paper (of which government is generally the largest component). Since the US issue so much debt that everybody buys the money cannot be spent on goods! If Barack Obama really wants to double exports in 5 years he can do it in a heartbeat by refusing to sign the next debt level increase legislation to hit his office. Obviously this implies hard political choices which I don’t mean to discount so caricaturally. China’s peg works by purchasing US financial assets, stop issuing them and China will not be able to buy them. The peg will then collapse without outright adoptions of the US dollar. Since China is so hell bent on controlling its internal economy, sacrificing the totality of its monetary policy sovereignty to another country is probably not in the cards.

The lesson while somewhat different for the PIIGS is essentially the same. Get competitive or get punished “à la Grecque”. Stop living above your means. Whether in a monetary union or even in a free floating currency regime, free lunches don’t exists, you’ve got to pay the piper someday. So Brazil and Canada pipe down will you, stop blaming your woes on currencies that refuse to act conveniently to your politics. To the US, ”Buy-American”, quantitative easing et al. are really cheap tricks. To any and all thinking of tariffs and quotas, please look at what happened last time that was tried. So to all China haters in the US or Germanophobes in Greece and the like, blame yourself for being ungovernable first, everybody else is just trying to do their jobs, time you started doing yours.

Cius