What Great Recession?

A follow up on my post concerning the performance of US companies versus the unemployment rate was contained in an article by Neil Reynolds in the Globe and Mail business section on March 30 2011.  

Reynolds contends that while certain sectors of the US economy were severly mauled by the great recession the "average" family and the country on the "average" did quite well.  For example US disposable income adjusted for inflation fell by a mere $99 in 2009 and it increased in 2010 to an all time record of $33,019.  The average net worth of the average American household did not fare as well.  Net worth fell sharply n 2007 but is now increasing by $20,000 per household in 2010 restoring net worth to its mid 1990s level.  The decrease in household net worth is a direct result of a decrease in the value of Americans' homes but for those who did not sell or were not forced to sell or remortgage this is paper loss.  There is strong evidence that a person's home will continue to be a significant part of his or her's net worth. 

How badly was domestic per capital Gross Domestic Product hurt during the recession?  Not badly at all. In 2000 the per capita GDP was almost $38,000.  In 2010 the per capital GDP was almost $43,000.  These numbers are adjusted for inflation.

The article goes on to explain that most of the stimulus money was used to pay down debt.  Americans who were, during most of the first decade of the millennium, experiencing a negative savings rate (that is they were spending more than they earned) are now saving at a rate of over 5% (as a percentage of disposable income).  This takes them back to the 1960's savings rate.

The conclusion of the article is that most Americans are better off this year than they were last year.  "The average household is not unemployed.  The average household is not homeless.  The average household hasn't slipped into poverty".  The average household is saving more than at any time since the 1960s. 

We know that employment lags recovery after a recession.  While employers will spend large amounts of money on machinery, equipment and software that makes their company more efficient, hiring is a human commitment has has far reaching obligations.  This is particularly true if the employer is unionized.  However, employment can't lag indefinitely.  There are jobs that only humans can do.  So it appears that the success of corporations is a harbinger of better things to come.

But averages are just averages.  There are a great number of Americans that are in distress.  There are a large number of people who are homeless and there are a large number of people whose work prospects are dim for the rest of their working (or non-working) lives.  The country is experiencing huge deficits and and unparalleled sovereign debt load.  The tax system will have to absorb corporation's previous losses before the new found prosperity has any positive effect on tax revenues.  The US will have to find a way to transition those in distress to the new prosperity.  Some may have to be retrained.  Some will have to accept work at lesser salaries than what they were formerly earning.  Some may never work again.  Some may never own a home again.  However, I believe that the US economy, the largest in the world, can absorb these social costs.  It will take creative political leadership to achieve this goal.  But, I believe that it can be done.

So this may explain further why the Dow is doing so well while the unemployment rate is extremely high.  In my last post I indicated that large American corporations were doing well and unemployment has only come down marginally.  My post indicated that the cheap dollar was fueling foreign sales.  While that is probably true another factor may be that, on the average, the American household is not doing too badly at all. The lines at the Apple store for the iPad2 are a testament to that.

This is extremely good news for Canada whose economy is highly dependent of the American economy.

Bernie.  

More Profits, Fewer Jobs

I don't have time for a post tomorrow so I thought that I would send along an excellent article in Slate Magazine on why US companies are awash in profits and cash and yet the unemployment rate remains high. See:

More Profits, Fewer Jobs
By Annie Lowrey
http://www.slate.com/id/2289619?wpisrc=sl_ipad

Not covered in the article is the fact that the US stock markets (Dow, S&P, Nasdaq) continue to be strong while other economic fundaments are in the toilet. Consumer demand is down, unemployment is high, the housing market is at an all time low and many of the states are virtually bankrupt. One answer may be that the US has steadfastly kept a lid on its currency thereby making American goods a bargain abroad. Most of the companies cited in this article have a very strong ex-American presence. Also what is not covered in this article (but covered generally in the financial press) is that these profits are generating few tax dollars for the US treasury. GE, for example, had $1B in profits but will pay no tax in the US due to loss carry forwards suffered in the down years. Would I bet on the Dow? Not yet.

Bernie

Neither a Borrower or a Lender Be

A piece in the Globe and Mail this morning on a platform item for the NDP brings to mind the quote from Shakespeare. The NDP would peg maximum credit card rates at 5%+Prime. At first blush this does seem to be such a bad idea. About a third of Canadians cannot pay off their credit card debt at the end of the month. But let's look closer.

In order to set the stage, the credit card companies such as Visa and MasterCard make money on the transaction fees paid by merchants. The loan portion of the transaction--that is when you don't pay the full balance at the end of the month is financed by a bank that sponsors the credit card.

Interest is rent for money and reflects both the cost of money and the risk that the borrower will not repay. Banks are not in the business of funding risk. But credit card divisions of banks do just that. They know, as a matter of statistics, that a significant number of their borrowers will not pay. So, the high rates of 19%+ reflects a rate that the credit worthy borrowers pay to subsidize those who do not pay. The fact that the return on equity by banks who advance this debt is not egregious, you can say that the system works well as it is. If you want to be frugal then credit cards cost you little beyond the annual fee that you pay your bank for issuing the card. If the rate subsidy was not correct and banks made a higher than normal return on equity then others would enter the field and drive down the rates through competition. Conversely if the rate subsidy was not correct and the banks made a lower than normal return on equity they would simply get out of the business.

My guess is that a prime + 5% cap on credit card fees would have a significantly adverse effect for the consumer and on the economy. I believe that this kind of return would not result in a reasonable return on invested capital to the bank. The subsidy would be too low. Since Visa and MasterCard does not want to get out of the business--merchants pay fees whether the customer pays or not--the banks would have to adjust its lending pool to reflect the right amount of subsidy. It would mean that a large number of customers would be dropped off the pool. This would, in turn, reflect a decrease of demand and stores would suffer. For an economy that is driven, for most part, by consumption this is not the right answer.

Economic evidence is that a significant increase in credit card rates does not affect demand much. So long as the minimum payment remains affordable the fact that the debt will not be paid off for 30 years does not seem to bother most consumers. There is rarely any "equity" in the loan--that is any real decrease in the principal. Increasing the minimum payment will have a significant effect on consumers. This is like requiring homeowners to come up with a larger down payment when buying a home. If the credit card debt were amortized over 10 years there would be an incentive on the part of the consumer to save. Those who could not pay the minimum payment would either buy for cash or postpone purchases until they had saved enough. Those who chose the minimum payment would have an affordable payment plan that would give them some equity in the debt in the near term. It would make a nation of savers out of Canadians rather than a nation of deadbeats.

But, you say, such a plan would still have a negative effect on the economy. It would mean less purchases. True, that that decrease would be offset by savings that would, in turn, have a positive effect on the economy.

Bernie.

Money Makes The World Go Around

Regards from sunny Barbados.

A recent article that has made the rounds of the financial pages of many newspapers is that the US is taking steps, along with other nations, to increase the value of the Chinese currency in terms of other hard currencies (US dollar, Euro, etc.). China has notoriously kept the value of its currency low so that its goods, in relation to other currencies, can be imported at low cost to the buyer. We in Canada should know all about that. When our dollar was about 75 cents US, exporters basked in the glow in what amounted to a 25% subsidy of Canadian prices.

To most people the wax and wane of money on the international market is either of no consequence (unless you are shopping in the US) or is so complex that eyes glaze over and yawns are hardly stifled when the subject is brought up. This post hopes to be a "guide to the perplexed". So stifle your yawn.

We all know that money is a medium of exchange. If I have too many chickens and you have too many goats for our own consumption the only way we can trade is if we find a common denominator to value our goods, I price my chickens in terms of that denominator and you price your goats in terms of that denominator and we trade. The denominator is the local currency. This currency can be as common as shells or as strictly controlled as government controlled paper currency. So long as the supply of that currency is stable (no counterfeiting allowed) prices will remain stable. Happily I will not write about what happens when the currency supply becomes unstable--like inflation. Maybe for another post.

All of this works well if we are on an island and we all have what we and others on the island needs. Once we trade off the island--that is with someone who has currency other than our own--another set of rules apply. As between our foreign buyer and ourselves we have no common denominator. You will not accept his currency in payment for your products because you cannot spend that currency on your island. Similarly he cannot accept yours if the trade is the other way. Therefore, before a trade can be made, he must first buy your currency and then trade. Money traders have been engaged in this business for centuries. They buy and sell currencies. What the buyer has to take into account is the cost of buying your currency (if it's a one for one trade then no one suffers; if he gets two of your currency for one of his, i.e. your currency is worth half of his, he is (all other things being equal) a big winner). You, as the local seller do not care. You satisfy your needs with your own currency. So, simply stated, the lower the value of your currency in terms of the foreign purchaser's currency the cheaper your goods are in terms of his currency.

So far so good. Let's take chickens. Lets assume your currency is worth half of the foreign buyer's currency. You want to sell your chicken for $10. It will cost the foreign purchaser $5 in his currency to buy the chicken. But if chickens in his country only sell for $3 then its no deal. He then has to buy your currency at a 70% discount to his currency in order to make a trade

But why are your chickens only worth $3 in terms of the foreigner's currency? Perhaps it is because his country raises chickens through mass production and you are still raising chickens on the farm. Therefore, the 70% discount in currencies reflect your inefficiencies in the production of chickens. In that way, relative currencies keep good score between the efficiencies in various economies. For years, the devalued Canadian dollar measured inefficiencies in the Canadian economy vis a vis the US economy. Some will say Canada caught up (though I doubt it) and therefore the US and Canadian dollars are roughly at par.

All this assumes that currencies can be bought and sold on an open market. If a country artificially reduces the value of its currency (how doesn't matter now) it will makes its goods less expensive in terms of other currencies. That is what China is doing. Aside from the low cost of labour and the efficiencies of mass production it is said that China is adding an additional "sale discount" to its goods by artificially keeping its currency low

What to do about it is for another post. Suffice to know just what's happening in the news.

Bernie.

The Right to Know

A case pending before the Ontario courts involves a divorce case between Mary Elizabeth Harriman and her husband (soon to be ex-husband) the notorious ex colonel Russell Williams.  It appears that soon after Williams’ confession he entered into a marriage contract with his wife transferring to his wife property either owned by him or owned jointly by them. The Ottawa Citizen and the CBC and CTV want the document to be disclosed and be available for public scrutiny. Ms. Harriman wants the document to be sealed and argues that she has had enough grief from the press without enduring yet another invasion of her privacy.  To complicate matters further there is a civil suit between Williams and one of his victims in which it is alleged that the marriage contract is a fraudulent preference shielding Williams’ assets from his creditors.  The court has not yet ruled. Who is right?

Normally courts rule in favour of openness.  The public’s right to know often trumps inconvenience and embarrassment of the person trying to suppress the document.  The assumption is that there is some public benefit to disclosure.  These cases usually involve governments who, for reasons of national security or otherwise, refuse to disclose volatile documents.  But why should the public have any interest in what was a private arrangement between Williams and his wife?  If the document has any relevance in a civil suit it will be disclosed to plaintiff’s counsel in the discovery process.  If I choose to give assets to my wife should this matter be publically disclosed and commented on by the press?

The press’s right to know has been enlarged over the past decades.  Governments have participated in this enlargement by passing omnibus freedom of information legislation that gives the public access to certain public documents.  The voracious appetite for news and the endless news cycle of cable stations such as CNN has fed on the expansion of the “right to know’ to the “right to know everything”.  The privacy of both public persona and the individual has suffered. 

Add to this the public’s disregard for its own privacy.  Contributors to Facebook and Twitter are not shy about revealing the most intimate details of their lives.  Acts of rape are transmitted through cell phones.  Teenagers send salacious pictures to their friends only to find out that these communications can go viral on YouTube. This disregard for personal privacy makes the courts less likely to rule in favour of the individual when the right to privacy comes up in civil litigation.  There is almost a presumption biased in favour of disclosure.

The invasion of personal privacy is everywhere.  From security cameras posted on public building that broadcast the image of persons passing by to Google that sends cars through cities in order to photograph cityscapes a person’s right to privacy is invaded every day.  Add to this invasive searches in the name of national security at airports and other transportation services and it becomes apparent that the right to privacy is not only eroding but its erosion is taken as a fact of life by the younger population.

These trends tend to embolden the media.  Who cares if the Williams’ engaged in some “estate planning” after his confession?  If anyone needs to know, really needs to know—such as a creditor—there is a way to make that available to the creditor without making it available to the world.  I hope that the judge sees it my way.

This is the last post for about a week.  Don’t be shy.  Post your comments.

Bernie.

The Politics of Politics

Why does a country like Canada have 4 elections in 7 years?  Why does a country that is supposed to be otherwise as dull as dust believe that yet another election will solve its structural problems?  For those with a long memory, minority governments are no stranger to the Canadian political landscape.  The following are minority governments since Confederation followed by the party and the prime minister of the day:

1921-1925	Liberal	William Lyon Mackenzie King
1925-1926	Liberal	William Lyon Mackenzie King
1926-1926	Conservative	Arthur Meighen
1926-1930	Liberal	William Lyon Mackenzie King
1957-1958	Progressive Conservative	John Diefenbaker
1962-1963	Progressive Conservative	John Diefenbaker
1963-1965	Liberal	Lester Pearson
1965-1968	Liberal	Lester Pearson
1972-1974	Liberal	Pierre Trudeau
1979-1980	Progressive Conservative	Joe Clark
2004-2006	Liberal	Paul Martin
2006-	Conservative	Stephen Harper

Except for the long reigns of Mackenzie King and Louis St. Laurent the country has chosen to be fractious and has elected many minority governments.

Consider the make up of Canada, old a new.  During the Mackenzie King and St. Laurent years Quebec was politically quiet under the iron fist of its fascist leader Maurice Duplessis.   With the rise of Quebec nationalism came a flexing of its political muscle both provincially and nationally culminating in a national party that is somewhat dedicated to the secession of Quebec from Canada.  The Canadian west and in particular the prairie provinces were home to some of Canada’s wackiest political parties (Social Credit) and some of it’s most socially conscious (the NDP).  The Maritime Provinces have been mainly a Liberal stronghold with a smattering of Conservative and NDP support.  Ontario, once a liberal stronghold has diluted that support to the benefit of both the Conservatives and the NDP.  The real balance of power in Canada lies with the Parti Quebecois.  Once a Liberal stronghold, Quebec can no longer deliver the votes that kept Louis St. Laurent and Trudeau in power.

Note the legislation that was enacted by minority governments:

•                In the 1960s, Pearson's minority Liberal government introduced several key components of Canada's modern social-welfare system, including universal health care, government loans for university students, the Canada Assistance Plan (CAP), and the Canada Pension Plan (CPP). These initiatives were in part due to the close cooperation between the Liberals and New Democratic Party during Pearson's minority governments.

•                Between 1972 and 1974, Trudeau introduced a program of economic nationalism that included the creation of Petro Canada. In addition, old age pensions were indexed to the cost of living. Again, this was due in part to the close cooperation between the Liberals and NDP during Trudeau's minority government.

Note that these significant pieces of legislation were enacted with the co-operation of the NDP.  This is the political alliance that were much touted as an alternative government in the past year until the Conservatives prorogued Parliament in what amounted to a coup d’état.  In recent years the Conservatives have governed without much input from the minority parties.  In fact the Conservatives have governed without much outside input from anyone.

The problem, as I see it, is in the center left of Canadian politics.  The Conservative party is made up of the rump Conservative party tied together with the prairie Reform Party.  This has moved the new Conservatives well to the right of Canadian politics.  The Liberal party used to occupy the center left.  However, the NDP has move sufficiently to the right to occupy most of the Liberal political space.  Therefore the Liberals are, as they are in the UK, becoming redundant.  There is not enough political space between the Liberals and the NDP to cause voters to choose definitively between one and the other.  The far right voters will now have to choose between Conservatives and the NDP.  The Liberals are are a much less significant factor in Canadian politics.  Until the political left center is occupied by a credible political party the Parti Quebecois will continue to hold the balance of power and we will continue to have minority governments.

Bernie.

The Budget and Other Mythologies

I am back from the sunny south. 

I remember being in lockups on budget day so that state secrets would not be leaked to the avaricious business community.  I also remember taking a significant part in the budget of 1984 as a consultant to the deputy minister of Department of Finance.  I therefore had an outside and insider's look at the budget process that you might find interesting.

The budget is made up of two or even three components.  First, there is the big picture.  This is the economic component of the budget that signals the government’s fiscal intent in the next year.  The second component is the “goodies” and “baddies” part of the budget that tries to fine tune existing provisions to the detriment or benefit of certain taxpayers.  Lastly there is the remedial part of the budget that tries to fix what is called “loopholes” in the legislation.

It appears to me that this budget was drafted knowing that it would never see the light of day as legislation.  There were obvious sops to the NDP.  The signs that government was to take on a much smaller dimension was offset by a tax gift to corporations that is sure to be translated to large party gifts from industry for the upcoming election.  The $300 tax credit to children participating in the arts is laughable.  The $3,000 tax credit to volunteer firemen seems excessive.  It was all for show.

However, the provisions aimed at plugging a “loophole” regarding flow through shares is interesting.  This loophole reduced the after tax cost of making a charitable gift to about 15 cents on the dollar This government has never been big on the arts and culture of the nation.  The flow through share mechanism did two things that seemed beneficial to Canada.  First, it funneled money into the extractive industries.  Many millions of investment dollars went to create jobs in the mining sector.  Second, it funneled money into the arts and other charities on a highly tax subsidized basis.  With the remediation of the so called loophole there will be a considerable swing of funds away from mining, the arts and other charities.  What appears strange is that this process was sanctioned by letters from CRA indicating that the process was quite legal and within the provisions of the Income Tax Act.  What changed the government’s mind?  No one knows for sure.  If you love the arts or hold mining stocks don't vote Conservative.

The other economic indicator that is worrisome is the stated aim to reduce the size of government.  There are several belt tightening provisions that require a freeze on hiring and the requirement that the departments do more with less. Shades of the Tea Party in the US. Having lived this long in the capital of Canada I know that government reduction plans are doomed to failure.  These usually result in the outsourcing of work that is hidden somewhere in departmental budgets.  Governments grow because they are tasked with more and more work as programs expand.  True that there could be significant efficiencies in government but, unlike the US, our government faces unions at almost every level that have the effect of perpetuating inefficiencies.  Like it or not, that’s the way it is.  Outsourcing makes the departmental spending process less transparent.  So why has the Conservative government participated in this pretense?  Its good politics.  It shows fiscal prudence that everyone knows is a sham. 

So, we’re in for another election.  More about that in a later post.