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?

Greece! Go Away!

I sometimes shiver with humiliation at the memories of my adolescence and the utter immaturity that characterized them. I comfort myself with the thought that I have outgrown them. I used to believe that people outgrew their baser adolescent instincts of selfishness, laziness and general disdain for responsibility, I could not phantom the possibility that an entire populace could degenerate into a mindless mob of collective adolescents. Greece has proved me oh so wrong. Now before anybody get’s up and antsy about the broad generalization I recognize that not all greeks are in the streets hooded in black and throwing fiery cocktails around. However, the despairing state of the Greek economy is the business of all those people and the general result of their cumulative collective decisions. The guilty parties are, in no particular order: tax evaders, union leaders and members, politicians, savers, voters, anarchists, socialists, wannabe monopolists, retirees, students and anyone silent on the going-ons of the county. That list I believe covers more or less the majority of the people from the small nation that gave the world democracy.

Reading up on the back and forth between Athens, the Troika and various European capitals I’ll admit to a sinking feeling of despair. Berlin’s demands just keep mounting and the absurdity of Greek politics never retreats. German flags are being burned in the streets of Greece, right-wing papers in the country compare Merkel to a Nazi while across the divide any remaining AAA country in the Euro are simply loosing interest in Greece who has proved a most unreliable partner in the battle for economic stability.

I’m no Keynesian but the repeated bouts of austerity demanded by Greece’s Euro creditors are pummelling the periphery’s economies harshly. I don’t believe I’ve ever heard a Monetarist or even an Austrian economist recommend pro-cyclical fiscal policy systemically. Austrians economists might say that recessions are good because they kill bad business models permitting the flowering of sustainable industry. However even the most die-hard fiscal hawks (me) have to admit that at an above 6% contraction yearly with no hope in sight for growth, even good businesses will flounder. That’s why fiscal consolidation in Greece needs to be accompanied by stimulus spending funded by the competitive parts of Europe. Pan-European unemployment insurance is the most sensible proposal that has not gone main stream yet. The moral hazard that will ensue is undeniable but until permanent mechanisms for intra-Euro fiscal transfers can be worked out, the benefits are surely worth the cost.

That said that the money masters’ responses to continued contraction in the periphery are inadequate, the reaction from the patients are increasingly unacceptable. In Italy the unions responses to the Monti plan for liberalization are tantamount to the summum of Human selfishness. While the house is burning the unions are trying to save their clothes while some are still trapped (the unemployed) admittedly while some have already fled (the tax evaders). The retired are equally deserving of blame silent on the whole affaire so long as their golden retirements are not threatened even when these same retirement plans are bankrupting their nation. But while Spain and Italy’s yields come down showing the markets forgiving side, or just the ECB vast manipulation skills, Greece and Portugal edge towards the brink. While tame in Lisbon, reactions in Athens are flaring up to an extreme.

I long ago learned that the most vociferous voices rarely represent or even understand the silent majority. The silent majority in most western countries are hard working middle class and relatively rational voters. Even when they are swindled into voting for a party that ill benefits their country’s these voters always (almost) correct their aim sending back their political systems to the center. This does not seem to be happening in Greece. Not only has the majority let its political leaders lead them to a path of reckless fiscal irresponsibility and stupidity, they now seem unwilling to admit to the wrongness of their ways. For God’s sake Greece’s politicians are asking to be the least trusted west of Tehran. Its anarchist youth are trying to give 80’s Italian terrorist youths a run for their money. To reverse an oft heard insult, the Greeks’ silent majority is about to be hoodwinked into poverty faster than Germans were into Nazism. Greeks have committed the cardinal sin of fiscal profligacy, they have been found guilty by the markets, they are now in a liquidity and solvency jail. The rest of Europe has posted bail, and now has promised to take Greece into a pseudo form of receivership in order to buy the fledging country a little decency and freedom. Greek response to the modest conditions demanded of it, spitting in the AAA’s faces. The audacity and hypocrisy demonstrated in the land of classical drama is baffling to say the least and shockingly amoral.

While I wish a speedy recovery for all of Europe and hope that the beauty of the European project can be furthered, I’d be lying if I didn’t say I believe the Greeks have lost all rights to participate in the next chapter of Europe’s history.

In praise of all that is German

Germany hasn’t been getting a lot of slack of late. Between accusations of trying to succeed where they’ve failed in two previous World Wars – dominating Europe – or accusations scuttling the European Project out of selfishness, and again with cries that Germany is abandoning the Euro, the nation of sauerkraut and beer is in the throws of a full blown Greek tragedy (lol pun intended). Asides from the on camera superficial Merkozy marriage, no french love seems to be crossing the Rhin. Further compounding the courteous hate fest, Italian flirting has gone from invitations to the bunga bunga parties (most often refused anyways) to the sober and stale Monti ear whispering for more cash. Somehow, I don’t think encouragements from the euro-sceptic nationalisty Finns was the recognition Berlin technocrats were looking for. The Euro area is eerily looking like an Animal Farm in the throes of its Orwellian infancy. Need I really specify which Euro countries are acting like over-eager egalitarian PIIGS, hrum I mean pigs, seeking the overthrow of opulent and oppressive markets, hrum… I meant masters. All punning aside, I believe there may be a little lack of balance in the debate over fiscal and monetary policy proposals to the Euro area mess.

Let’s start by awarding praise where it is due and sing the virtues of the German machine, hrum… economy sorry forgot about the inter-temporal analogy bank. To my knowledge German policymakers are the only ones of any major economy who seem to have learned the lessons of history. This is no coincidence as not-repeating the errors of history has become part of German culture. Little children are taught at school about the immeasurable harm generations of their ancestors have wrought upon the world (maybe even too zealously). A cursory look at the lessons young children learn from Dortmund to Munich, leaves the history amateur with a few residual lessons in economic virtue, that we shall survey here:

1) Inflation = bad. How so? Well inflation leads to economic inefficiencies most notable of which is the rise of unemployment, which then leads to socio-political problems we need not raise here. To see just how hawkish they are monetarily, read anything on the Bundesbank or even the ECB.

2) Trade competition = good (especially when your winning). How so? The best buffer when in hard times is to have a trade surplus and savings. Germany has been at the forefront of multilateral trade talks, especially in Europe (see European Union history) but also internationally. I guess Germans remember how bad Smoot-Hawley was for everyone and how good the life has been since… well… 1946 I guess.

3) Hard work = prerequisite to 2). Now I know this might sound sacrilegious to all of us westerners getting used to resting on the laurels of previous generations hard work but bear with me. Our current level of wealth is tied if anything to previous generations working hard, earning dough, not spending but saving dough in the bank account, that dough being magically transformed by the financial industry into fixed capital formation, a.k.a. every single piece of equipment, factory infrastructure that buttresses our current economies. If you didn’t follow the flow working harder than your living standard would entail serves as the anvil of tomorrows wealth. Germans get that, they preach it, than they actually do it. This saving/underspending/fixed capital forming needs to happen at the household level, the firm’s level and the governmental one.

4) Mash up all of the above = hawkishness in every sphere of public policy (and private actually) = kicking the worlds butt economically.

So what has been going on exactly in Europe? following the above stated framework for success lets see where things went wrong. Europe was a place of high savings (or at least American savings though the Marshall Plan)a, hard working and rebuilding for while following WWII. No problems so far. Italy, Britain and France had thriving industries, peripheral Europe slowly started democratizing itself. Than they started moving towards the European Union. Savings and investment flows started getting a little complex at this point. Big Euro countries started saving for peripheral ones, sending money so that those countries could invest in infrastructure modern

isation and other stuff of the like. Eventually thy took a bunch of countries with a myriad of fiscal and monetary systems and patched them together into a big currency block. Germany kinda knew where this was going so they tried the  true and tested policies. They retrenched further into fiscal and macro-prudential austerity. So yes this national savings craze as measured by a current account surplus peaking at 7.4% of GDP just before the crisis hit in 08, did lead to some imbalances within the Euro block by depressing Euro wide inflation numbers and interest rates. The real trouble however wasn’t German economic virtue it was the rest of Euro countries, more particularly the PIIGS, reaction to these circumstances. How did they react, like all good socialisty, humanisty, mushy hearted westerners, they indulged in profligate entitlement spending. Riding on the coattails of previous generations of hard work and contemporary German virtue (i know redundant), they offered their people an easy life at low borrowing costs.

Then one day the masters hrum… markets, sorry, woke up and said “the break is over back to work”. The current crisis boils down to looking to the Germans and saying no we don’t want to work as hard as you! keep paying. Unfortunately markets tend to act like the tough love parents that they are and Germany seems content to not act like the over-indulgent parent its savings temporarily were. Now some might quibble that the crisis is one of solvency or simply liquidity needing some temporary patching to be corrected. What needs correcting is peripheral Europeans expectation of living standards they must go down! if they are one day to go up to Germany’s level. Increasing the ESM or EFSF or introducing eurobonds does not solve the problem. Even Angela Merkel’s suggestion of limiting federal governments deficits to 0.5% of GDP remains to timide a goal. Mario Monti is somewhat on the right track in Italy. Although his reforms are limited in scale they are in the right direction. A combination of fiscal austerity coupled with market liberalization is the equivalent of putting italians back to work. Less play more labour! is the key to making labour unions howl and incidentally generating long-term wealth. Let’s hope more european nations decide to go the german path to prosperity before the s*** really hits the fan.

Cius