Euro crisis is the biggest danger to world recovery, says OECD.
But it is hopeful. It expects output to increase faster in the near future. Provided fiscal cliff is avoided and Europe does not fall apart, growth will pick up by 2014, just in time for your graduation.
Thursday 29 November 2012
75. Greece will be ok
in 2020 or some time later.
But at least for now, they will live to fight another day. An agreement between the IMF and the Euro area lenders will provide the next installment of EU money and keep lights in Athens on.
For how long? It is difficult to say: " the IMF had stuck to a bottom line of getting the Greek debt level to 120% by 2020, far below what eurozone and IMF inspectors concluded was possible."
The agreement is to have Greek debt, in 2020, to fall only to 124% of GDP, rather than 120%. The IMF would like to have some of Greek debt forgiven; te creditor countries do not agree.
Everyone will now wait to German elections in 2014 which will clarify what German voters want.
In a pinch, there is always Super Mario. Who?
The guy in the picture, Mario Draghi, the president of the European Central Bank. ECB can pump money into the Euro area as needed.
PS. In case you were looking for a Christmas present - look on the right of the page
But at least for now, they will live to fight another day. An agreement between the IMF and the Euro area lenders will provide the next installment of EU money and keep lights in Athens on.
For how long? It is difficult to say: " the IMF had stuck to a bottom line of getting the Greek debt level to 120% by 2020, far below what eurozone and IMF inspectors concluded was possible."
The agreement is to have Greek debt, in 2020, to fall only to 124% of GDP, rather than 120%. The IMF would like to have some of Greek debt forgiven; te creditor countries do not agree.
Everyone will now wait to German elections in 2014 which will clarify what German voters want.
In a pinch, there is always Super Mario. Who?
The guy in the picture, Mario Draghi, the president of the European Central Bank. ECB can pump money into the Euro area as needed.
PS. In case you were looking for a Christmas present - look on the right of the page
Wednesday 28 November 2012
74. A job opening
A job just opened, that of the Gover nor of the Bank of Canada. A short description is here
Important points:
Important points:
- The Governor of the Bank of Canada is the Bank's chief executive officer, and, as such, has control and full authority over the business of the Bank. The Governor also presides over the Board of Directors.
- The Governor of a country's central bank must have a thorough understanding of financial markets and the economy and possess wide experience in international finance. There are eligibility requirements laid down in the Bank of Canada Act, including a requirement that the Governor must be a Canadian citizen.
-
The Governor is appointed for a fixed term of seven years.
If a profound disagreement on the conduct of monetary policy were to occur, the Minister of Finance, with the Cabinet's authorization, can issue a written directive to the Governor specifying a change in policy. No directive has ever been issued.
So once you get it, you are pretty safe.
73. The Bank of England job is more difficult
As you know, the governor of the Bank of Canada accepted an offer to become the head of the Bank of England. The job is supposedly more difficult. This article points out that, at the Bank of Canada, the governor is the most important member of the policy-making body (the Governing Council).
Decisions are made by consensus, and only the governor has the right to change interest rates. The governor explains the changes and other members of the Governing Council talk to various stakeholders (business groups, bankers, etc) and provide the same explanation. Nobody offers a dissenting opinion.
In the Bank of England members of the policymaking body vote on the decision. Disagreement are accepted and dissent noted. The governor has less power.
David Dodge, Mr. Carney's predecessor points out other differences:
1. Bank and regulator talk to each other in Canada, less so in the UK;
2. Bank of England is responsible for bank regulation, Bank of Canada is not
3. What is the biggest financial centre in the world?
So Mr. Carney chose to be a smaller fish in a bigger pond. Given his character, he will try to become a big fish in the bigger pond. We will see how it goes.
By the way, the governor of the Bank of Canada has to be Canadian (see the next post), the governor of the Bank of England does not have to be British.
But, apparently, there is not much to do for the first 18 months
Decisions are made by consensus, and only the governor has the right to change interest rates. The governor explains the changes and other members of the Governing Council talk to various stakeholders (business groups, bankers, etc) and provide the same explanation. Nobody offers a dissenting opinion.
In the Bank of England members of the policymaking body vote on the decision. Disagreement are accepted and dissent noted. The governor has less power.
David Dodge, Mr. Carney's predecessor points out other differences:
1. Bank and regulator talk to each other in Canada, less so in the UK;
2. Bank of England is responsible for bank regulation, Bank of Canada is not
3. What is the biggest financial centre in the world?
So Mr. Carney chose to be a smaller fish in a bigger pond. Given his character, he will try to become a big fish in the bigger pond. We will see how it goes.
By the way, the governor of the Bank of Canada has to be Canadian (see the next post), the governor of the Bank of England does not have to be British.
But, apparently, there is not much to do for the first 18 months
Monday 26 November 2012
72. World economy in poor shape but our exports increase
Here is why: the Governor of the Bank of Canada, Mike Carney, will become the Governor of the Bank of England. It is a more interesting job as UK is a mess.
It is also a testimony to the excellent job of Bank's board. Mr Carney was selected from outside of the Bank 9 years ago.
It is also a testimony to the excellent job of Bank's board. Mr Carney was selected from outside of the Bank 9 years ago.
71. Three articles on taxes in the US
1. by Paul Krugman, Nobel Prize winner, a columist at NYT and a leading progressive economist.
Krugman argues that we should not worry about the deficit at present. The economy is weak and austerity (increasing taxes and reducing spending) can wait until the economy improves.
He argues that people who have been warning about the perils of the current deficit in the US are exagerating. The US economy is no Greece. Even though deficits are very high, interest rates are at historical lows.
Question: Indeed, even though the deficit in the US is greater than in Greece (as percentage of GDP). What is the main difference between Greece and US causing it not to be a problem?
2. by Steven Rattner, an investment banker who led the auto bailout
The main problem in the "fiscal cliff issue" is what to do with Bush tax cuts. In 2001-2003 the Bush administration cut the top tax rate from 39.6% to 35%. Republicans are against the return to old rates for anyone; Democrats want to increase tax rates on people making more than $250 000. Ratner looks at alternatives. These include limiting deductions, introducing minimum taxes on the rich etc.
\
3. Warren Buffett wants to pay a higher tax rate than his secretary.
Warren Buffett, the most successful investor in the world, started a debate on tax fairness by pointing out that his secretary pays a higher tax rate than he does. He suggests that:
- taxes on dividends can be raised without causing disruption in the economy
- there should be a "Buffett tax": anyone making over $1 mln should pay at least 30% in federal tax.
The argument against raising taxes is that it would depress investment. The return on investment is the amount after tax; the higher is the tax rate, the lower is the benefit of investment.
Buffet argues that, for the rich, the effect does not apply. They work hard making money regardless of tax rates. Note the extraordinarily high tax rates in the past.
Krugman argues that we should not worry about the deficit at present. The economy is weak and austerity (increasing taxes and reducing spending) can wait until the economy improves.
He argues that people who have been warning about the perils of the current deficit in the US are exagerating. The US economy is no Greece. Even though deficits are very high, interest rates are at historical lows.
Question: Indeed, even though the deficit in the US is greater than in Greece (as percentage of GDP). What is the main difference between Greece and US causing it not to be a problem?
2. by Steven Rattner, an investment banker who led the auto bailout
The main problem in the "fiscal cliff issue" is what to do with Bush tax cuts. In 2001-2003 the Bush administration cut the top tax rate from 39.6% to 35%. Republicans are against the return to old rates for anyone; Democrats want to increase tax rates on people making more than $250 000. Ratner looks at alternatives. These include limiting deductions, introducing minimum taxes on the rich etc.
\
3. Warren Buffett wants to pay a higher tax rate than his secretary.
Warren Buffett, the most successful investor in the world, started a debate on tax fairness by pointing out that his secretary pays a higher tax rate than he does. He suggests that:
- taxes on dividends can be raised without causing disruption in the economy
- there should be a "Buffett tax": anyone making over $1 mln should pay at least 30% in federal tax.
The argument against raising taxes is that it would depress investment. The return on investment is the amount after tax; the higher is the tax rate, the lower is the benefit of investment.
Buffet argues that, for the rich, the effect does not apply. They work hard making money regardless of tax rates. Note the extraordinarily high tax rates in the past.
Wednesday 21 November 2012
70. Greece - more problems
Finance ministers of the Eurozone did not come to an agreement on how to make Greek financial situation viable
The current goal is to for Greek debt/GDP ratio to fall to 120% in 2020. It is clear now it is not going to happen. An estimate says it will be 144%. There are three solutions
1. Stop support and let Greece go bankrupt. This seems to be the least preferred option.
2. Cut Greek debt
3. Lend Greece more money and reset the 120% goal to 2022.
Cutting Greek debt is the simplest approach, but
- Germany argues that, for debt to the EU, it cannot be done legally. The special fund that has been lending Greece money can only lend, not make grants;
- ECB (the European Central Bank) which holds a large portion of Greek debt would not agree;
- debt forgiveness for Greece would be unfair to countries that made the necessary reforms: Portugal and Ireland;
- debt forgiveness would entrench bad fiscal behaviour in Greece.
The current goal is to for Greek debt/GDP ratio to fall to 120% in 2020. It is clear now it is not going to happen. An estimate says it will be 144%. There are three solutions
1. Stop support and let Greece go bankrupt. This seems to be the least preferred option.
2. Cut Greek debt
3. Lend Greece more money and reset the 120% goal to 2022.
Cutting Greek debt is the simplest approach, but
- Germany argues that, for debt to the EU, it cannot be done legally. The special fund that has been lending Greece money can only lend, not make grants;
- ECB (the European Central Bank) which holds a large portion of Greek debt would not agree;
- debt forgiveness for Greece would be unfair to countries that made the necessary reforms: Portugal and Ireland;
- debt forgiveness would entrench bad fiscal behaviour in Greece.
69. Fiscal cliff warning
now from the Chairman of the FED. He warns that if nothing is done, the US economy will fall into recession.
68. What banksters are really afraid of
What is it? Insider trading. Why are they afraid of insider trading? Because it is prohibited by law and perpetrators go to jail.
So, to make bankers more accountable for their actions, better enforcement and jail penalties would do marvels. But somehow this does not happen.
There is more. Some insider trading is actually legal. How does it work? When new economic data are released, they often provide new information and markets move (you may have seen the movie "Trading Places". In this movie the information is the release of an estimate of the Florida orange crop; money is made by trading in frozen orange juice futures).
To allow everyone to have the same information, institutions (both private and public) that release data have a "lockup" period: data are announced to everyone publicly at a predetermined hour.
But in fact not everybody gets the information at the same time. High-frequency traders - firms that trade stocks very often with the help of computer algorithms, get it earlier. How? They pay the stock exchange for a direct line to their information system. This allows them to get information up to 50 nanoseconds before others. They can conduct trades in under 20 nanoseconds. So they can trade on the new information before others get it.
The definition of insider trading: trading using info not publicly available. Indeed, this is what is happening.
Who benefits:
1. High frequency trading firms
2. Stock exchanges that get paid for direct access.
And somehow it is legal. Beats me.
You can read about another example here
So, to make bankers more accountable for their actions, better enforcement and jail penalties would do marvels. But somehow this does not happen.
There is more. Some insider trading is actually legal. How does it work? When new economic data are released, they often provide new information and markets move (you may have seen the movie "Trading Places". In this movie the information is the release of an estimate of the Florida orange crop; money is made by trading in frozen orange juice futures).
To allow everyone to have the same information, institutions (both private and public) that release data have a "lockup" period: data are announced to everyone publicly at a predetermined hour.
But in fact not everybody gets the information at the same time. High-frequency traders - firms that trade stocks very often with the help of computer algorithms, get it earlier. How? They pay the stock exchange for a direct line to their information system. This allows them to get information up to 50 nanoseconds before others. They can conduct trades in under 20 nanoseconds. So they can trade on the new information before others get it.
The definition of insider trading: trading using info not publicly available. Indeed, this is what is happening.
Who benefits:
1. High frequency trading firms
2. Stock exchanges that get paid for direct access.
And somehow it is legal. Beats me.
You can read about another example here
Monday 19 November 2012
67. Risk behaviour of banks
The third article in the Bank of Canada review looks at bank behaviour when returns are low. It concludes that banks, in search of return, take on riskier activities, reducing requirements for risky borrowers. This is called the risk-taking channel of monetary policy. It works like this: as the central bank lowers interest rates to stimulate borrowing and investment, banks take on riskier projects, making it easier to get credit and strengthening the effect of the policy.
66. Money as a store of value; seigniorage as tax on crime
In the recent Bank of Canada report one article deals with cash holdings. The proportion of all transactions done in cash fall over time, but cash holdings increase in line with spending.
The authors of the article suggest that people hold savings in cash. This is not surprising: with nominal interest rates at record lows, the interest lost from holding cash instead of a bank deposit is minimal.
At the end the article mentions an interesting story that appeared in the National Post on Friday. The Bank of Canada stopped issuing the $1000 bill long time ago, and if a bank receives such bill it is sent to the Bank of Canada and destroyed. Yet there are still almost a million $1000 bills in circulation, with the value of almost $1bln. All this is seigniorage, paid by people using them, most likely for illegal activiites.
By the way, when Euro was introduced in 2002, the largest banknote was 500 Euro. This led to complaints by the US; Americans claimed, correctly, that this was an attempt to capture seigniorage away from the US. The $100 US is the most popular form of cash among criminals; using 500 euro notes instead reduces the size of suitcases cash needs to be carried in :). Cash used outside the country is pure seigniorage; the US would like to keep all of it.
And an interesting factoid: when the war in Iraq started in 2003, one of Saddam Hussein sons reportedly drove up to the Iraqi central bank to make a withdrawal of around $1 billion. He reportedly took $900mln in US cash and the rest in Euros. The money was later used to fund Iraqi insurgency.
The authors of the article suggest that people hold savings in cash. This is not surprising: with nominal interest rates at record lows, the interest lost from holding cash instead of a bank deposit is minimal.
At the end the article mentions an interesting story that appeared in the National Post on Friday. The Bank of Canada stopped issuing the $1000 bill long time ago, and if a bank receives such bill it is sent to the Bank of Canada and destroyed. Yet there are still almost a million $1000 bills in circulation, with the value of almost $1bln. All this is seigniorage, paid by people using them, most likely for illegal activiites.
By the way, when Euro was introduced in 2002, the largest banknote was 500 Euro. This led to complaints by the US; Americans claimed, correctly, that this was an attempt to capture seigniorage away from the US. The $100 US is the most popular form of cash among criminals; using 500 euro notes instead reduces the size of suitcases cash needs to be carried in :). Cash used outside the country is pure seigniorage; the US would like to keep all of it.
And an interesting factoid: when the war in Iraq started in 2003, one of Saddam Hussein sons reportedly drove up to the Iraqi central bank to make a withdrawal of around $1 billion. He reportedly took $900mln in US cash and the rest in Euros. The money was later used to fund Iraqi insurgency.
65. Interest rates and bond prices
We will be talking about it on Tuesday. Here is an article that says just that: if interest rates rise, bond prices fall.
Bond ETF (Exchange Traded Funds) are saving instruments sold to general public which follow bond prices. With interest rates at historical low, interest rates are likely to go up and bond ETF prices to go down.
The article mentions a simple calculation of bond losses from increase in interest rates. It is that, for a 1% increase in the interest rate, the price of bond will lose n% where n is the number of years to maturity.
This calculation is not quite correct; you will learn the detailed formula in your finance class.
Bond ETF (Exchange Traded Funds) are saving instruments sold to general public which follow bond prices. With interest rates at historical low, interest rates are likely to go up and bond ETF prices to go down.
The article mentions a simple calculation of bond losses from increase in interest rates. It is that, for a 1% increase in the interest rate, the price of bond will lose n% where n is the number of years to maturity.
This calculation is not quite correct; you will learn the detailed formula in your finance class.
Sunday 18 November 2012
64. And finally it happened!
For the first time, a rating agency was found responsible for bad ratings.
In Australia a court found that Standard and Poor liable for incorrect AAA rating for securities issued by ABN-Amro, a Dutch bank. According to the website: "The court ruled that S&P’s rating of AAA was misleading and deceptive and that S&P along with the issuing bank had been involved in the publication of information and statements that were false in material particulars and involved negligent misrepresentations being made to potential investors".
You also get an idea of the internationalization of financial markets. The securities were issued by a Dutch abnk, and bought by Australian municipalities.
In Australia a court found that Standard and Poor liable for incorrect AAA rating for securities issued by ABN-Amro, a Dutch bank. According to the website: "The court ruled that S&P’s rating of AAA was misleading and deceptive and that S&P along with the issuing bank had been involved in the publication of information and statements that were false in material particulars and involved negligent misrepresentations being made to potential investors".
You also get an idea of the internationalization of financial markets. The securities were issued by a Dutch abnk, and bought by Australian municipalities.
Thursday 15 November 2012
63. This sucks
Eurozone back to recession. Output fell in the second quarter by 0.2% and in the third quarter by 0.1%. Two consecutive quarters of output decline = recession
And it all started because a small country (Greece) cheated with its budget reporting and was borrowing 5% more than they said they did (or about $20 billion a year). Investors woke up from their unfounded belief that all is great and stopped lending to Greece, then Portugal, Ireland, Cyprus, Spanish banks etc. Total losses so far: trillions of dollars. The mouse ate the elephant.
And it all started because a small country (Greece) cheated with its budget reporting and was borrowing 5% more than they said they did (or about $20 billion a year). Investors woke up from their unfounded belief that all is great and stopped lending to Greece, then Portugal, Ireland, Cyprus, Spanish banks etc. Total losses so far: trillions of dollars. The mouse ate the elephant.
Tuesday 13 November 2012
62. The benefits of technology
According to International Energy Agency, the US will become the biggest producer of oil in the world by 2035. This is because of two developments: fracking technology that allows to get oil and gas trapped in rock formations (this technology s so new that the blog's spell checker does not know it) and horizontal drilling (no idea how they do it) which allows to extract up to four times the amount of oil from oil fields than earlier techniques.
When I was a student, a report of the Club of Rome painted a picture of resources being exhausted in the not too distant future. According to the report, it would have happened by now. But, as Yogi Berra famously said, "predictions are difficult, especially about the future"(actually, the first person attributed with this comment is the famous Danish physicist Niels Bohr - see here).
That, of course, does not mean that we should not conserve resources. While techonology helps, resources are finite. The International Energy Agency report takes into account conservation (for example fuel consumption standards) in its forecasts.
By the way, who is Yogi Berra? A baseball player with a fine sense of humour.
When I was a student, a report of the Club of Rome painted a picture of resources being exhausted in the not too distant future. According to the report, it would have happened by now. But, as Yogi Berra famously said, "predictions are difficult, especially about the future"(actually, the first person attributed with this comment is the famous Danish physicist Niels Bohr - see here).
That, of course, does not mean that we should not conserve resources. While techonology helps, resources are finite. The International Energy Agency report takes into account conservation (for example fuel consumption standards) in its forecasts.
By the way, who is Yogi Berra? A baseball player with a fine sense of humour.
61. Deficits will end a year later than expected
says our Finance Minister in the budget update (more on it later).
60. The fiscal cliff is everywhere
In today's National Post there are two articles of note. They are alarming, to say the least:
1. It will plunge Canada into a recession, says our Finance Minister.
2. It has not happened yet but the uncertainty is already hurting the economy, say the heads of Goldman Sachs and Bank of America.
1. It will plunge Canada into a recession, says our Finance Minister.
2. It has not happened yet but the uncertainty is already hurting the economy, say the heads of Goldman Sachs and Bank of America.
Monday 12 November 2012
59. The crunch in Greece.
Greece is, possibly, on its last legs. On Friday it needs to repay the European Central Bank 5 billion Euros. As it cannot borrow in international markets, it wants to borrow from Greek banks. The problem: the banks do not have enough cash to lend. To get the cash they need to provide a collateral, but they are also out of good collateral. So the collateral requirements need to be relaxed. In the end, they will most likely manage, and the funds will come from the ECB.
In other words, ECB will lend to others to have its own loan repaid by the Greek government.
It is similar, but not exactly the same, as a Ponzi scheme. In the Ponzi scheme, nobody knows the schemer borrows to pay of earlier debts. Here it is in the open.
In other words, ECB will lend to others to have its own loan repaid by the Greek government.
It is similar, but not exactly the same, as a Ponzi scheme. In the Ponzi scheme, nobody knows the schemer borrows to pay of earlier debts. Here it is in the open.
58. On central bank goals
While the Bank of Canada has one goal - making sure that inflation is between 1% and 3% and trying to maintain it close to 2%, the FED's task is more complicated: they have to control inflation, unemployment and interest rates. This is like hitting three birds with one stone: possible when they line up just so, but not likely. In this article Mike Moffat argues that the FED should concentrate on inflation. He points out two reasons: 1. it is not clear what unemployment rate should the FED target
2. It is not clear what tradeoff between inflation and unemployment should be.
ad 1. The central bank should target the natural rate of unemployment (the article uses NAIRU, which is a similar concept). But the FED does not know what the natural rate is. If it targets a rate that is too low, inflation will rise over time; if it targets the rate that is too high, there will be deflation.
ad 2. Dr Moffat asks a straightforward question: if a recession raises the unemployment rate to 10%, how high inflation should the FED tolerate to bring the unemployment rate down? Is 7% acceptable? Is 20%? It is difficult to say.
2. It is not clear what tradeoff between inflation and unemployment should be.
ad 1. The central bank should target the natural rate of unemployment (the article uses NAIRU, which is a similar concept). But the FED does not know what the natural rate is. If it targets a rate that is too low, inflation will rise over time; if it targets the rate that is too high, there will be deflation.
ad 2. Dr Moffat asks a straightforward question: if a recession raises the unemployment rate to 10%, how high inflation should the FED tolerate to bring the unemployment rate down? Is 7% acceptable? Is 20%? It is difficult to say.
Thursday 8 November 2012
57. Flexible labour markets
In the last lecture we studied labour demand. One factor was the the ease with which workers are hired and fired. The easier it is, the higher is labour demand since firms do not have to worry they will be stuck with unwanted workers when demand for their products falls.
This article is about the latest installment of EU help for Greece. As we mentioned, a worker who loses a job is entitled to a high severance payment. This was considered a problem and so one of the conditions imposed on Greece was introducing "measures making it easier to hire and fire workers".
By the way, the article describes how the process works. If Greece was to borrow in the open market, it would be paying around 20% interest on 10-year bonds. This is way too much so Greece is borrowing from a special fund set up by the EU, to which all EU countries contributed.
As a condition for the borrowing conditions are imposed on Greece. In this case, apart from job market reforms, it is required to reduce deficit by $17 billion.
The conditions have to be approved by the Greek parliament. Then protests erupt in the streets. But, as someone who was asked what he thinks of old age replied: "I prefer it to the alternative." If Greece does not get the help, it would either have to default on debt payments, or stop paying government employees, pensioners, welfare recipients, unemployed etc. Stopping government payments is, essentially, forced borrowing, mostly from the vulnerable part of the population.
This article is about the latest installment of EU help for Greece. As we mentioned, a worker who loses a job is entitled to a high severance payment. This was considered a problem and so one of the conditions imposed on Greece was introducing "measures making it easier to hire and fire workers".
By the way, the article describes how the process works. If Greece was to borrow in the open market, it would be paying around 20% interest on 10-year bonds. This is way too much so Greece is borrowing from a special fund set up by the EU, to which all EU countries contributed.
As a condition for the borrowing conditions are imposed on Greece. In this case, apart from job market reforms, it is required to reduce deficit by $17 billion.
The conditions have to be approved by the Greek parliament. Then protests erupt in the streets. But, as someone who was asked what he thinks of old age replied: "I prefer it to the alternative." If Greece does not get the help, it would either have to default on debt payments, or stop paying government employees, pensioners, welfare recipients, unemployed etc. Stopping government payments is, essentially, forced borrowing, mostly from the vulnerable part of the population.
Wednesday 7 November 2012
56. A good development
A big problem in the last four years was the unwillingness of congress Republicans to cooperate on fiscal matters with Democrats. They demanded that any changes consist 100% of spending cuts, and that taxes cannot be raised. This may now change. The House Speaker said yesterday that House Republicans are ready to cooperate and will accept higher taxes under the right conditions. Perhaps Thelma and Louise ending can be avoided.
55. Stock markets after the election or Why you should understand economics
I have found a good example of the problem that has been bugging me for a long time: explanations of what happened in the stock market. There is a whole industry trying to explain each day what happened: why stocks went up, why they went down etc. The problem is that, even with the benefit of hindsight, some of those comments do not make much sense. Hindsight is supposedly 20/20, but not in the case of financial commentators. I do not know why. But I do know that all these explanations sound plausible. To distinguish good from bad from nonsense you need basic financial and economic knowledge.
So to the example. Yesterday President Obama was reelected. Today markets fell by around 3%. Why?
This article explains that "investors' focus shifted to the looming "fiscal cliff" debate and Europe's economic troubles."
That article explains that "despite the fact that polls had been indicating for some time that President Obama was likely to win, that expectation was not shared by many financiers."
Who is right? The first article sees investors as not being able to do two things at once: follow an election and focus on the fiscal cliff and Europe's problems. They devoted all their attention to the election and only with the election over they noticed other problems.
That is silly.
The second article uses reasoning based on one conclusion from the efficient markets hypothesis: expected events do not affect stock markets. So the fact that markets reacted negatively to Obama's win means that investors did not believe he will win. That is surprising because the numerous polls left little doubt, but never underestimate people's ability to delude themselves in political matters.
So the second explanation makes sense, the first does not.
In the future you will be playing the markets so you need to understand the causes of market movements.
So to the example. Yesterday President Obama was reelected. Today markets fell by around 3%. Why?
This article explains that "investors' focus shifted to the looming "fiscal cliff" debate and Europe's economic troubles."
That article explains that "despite the fact that polls had been indicating for some time that President Obama was likely to win, that expectation was not shared by many financiers."
Who is right? The first article sees investors as not being able to do two things at once: follow an election and focus on the fiscal cliff and Europe's problems. They devoted all their attention to the election and only with the election over they noticed other problems.
That is silly.
The second article uses reasoning based on one conclusion from the efficient markets hypothesis: expected events do not affect stock markets. So the fact that markets reacted negatively to Obama's win means that investors did not believe he will win. That is surprising because the numerous polls left little doubt, but never underestimate people's ability to delude themselves in political matters.
So the second explanation makes sense, the first does not.
In the future you will be playing the markets so you need to understand the causes of market movements.
Tuesday 6 November 2012
54. More alarm
The election is today and people are already worrying about the fiscal cliff.
This is a very good article that deals both with economics and politics of the fiscal cliff. You should read it
This is a very good article that deals both with economics and politics of the fiscal cliff. You should read it
Monday 5 November 2012
53. The fiscal cliff - a wake up alarm
Since posts 45 and 46,policymakers finally expressed alarm about the fiscal cliff. In Mexico City on Sunday, finance ministers of G20 called the fiscal cliff the biggest danger to the world economy (although some were more worried about the Eurozone crisis).
Jim Flaherty, our Finance minister, said the fiscal cliff is the biggest danger to the Canadian economy
You heard it here first (about the danger of the fiscal cliff) .
Jim Flaherty, our Finance minister, said the fiscal cliff is the biggest danger to the Canadian economy
You heard it here first (about the danger of the fiscal cliff) .
52. The Euro Crisis
In the search of a good source (since we cannot use the Globe any more) I found a very useful set of data at the BBC website. It provides data on GDP growth, unemployment rate, deficit and debt for Euro-zone countries and the UK since 1999.
You should look at the data and play with the interactive graphics. I did, and here are some observations:
1. Unemployment: compare Germany with Spain and with Greece. The unemployment rate in Greece was lower than in Germany as late as in the second quarter 2008, the unemployment rate in Spain was lower than in Germany in the third quarter of 2007. Then the paths diverged. Since the third quarter of 2007 the unemploymnet rate in Germany fell by 3%; the unemployment rate in Greece and in Spain increased by over 15%.
2. In some European countries the Great Recession had little effect on the unemployment rate. Look at the graphs for Austria, Belgium, Germany and the Netherlands. At the other end are Slovakia and especially Estonia, where unemployment increased a lot, but started falling quickly.
3. The five countries that received EU help (Cyprus, Greece, Ireland, Portugal and Spain) all recorded very high increases in unemployment. Ireland seems to be past the worst period; the others are not.
4. The last time any country had a budget surplus was in 2008; since then every country except Estonia has been running a deficit. Deficits in some countries are absurd. The Irish government guaranteed bank debt and had a deficit of over 30% in 2010. Greece, Spain and UK seem to be basket cases.
5. Under the Maastricht treaty that created the Euro, debt to GDP ratio should be under 60%. Belgium, Greece and Italy have never reached that limit. In most countries it is now above 60%
6. Finally, look at two countries that are in good shape: Finland and Estonia. They have no debt or deficit problem. Estonia went through a wrenching recession but recovered remarkably well. Two years ago its unemployment rate was the highest after Spain; now it is less than a half of Spanish rate. Finland also went through a deep recession. Note that both countries have relatively high rates of unemployment.
You should look at the data and play with the interactive graphics. I did, and here are some observations:
1. Unemployment: compare Germany with Spain and with Greece. The unemployment rate in Greece was lower than in Germany as late as in the second quarter 2008, the unemployment rate in Spain was lower than in Germany in the third quarter of 2007. Then the paths diverged. Since the third quarter of 2007 the unemploymnet rate in Germany fell by 3%; the unemployment rate in Greece and in Spain increased by over 15%.
2. In some European countries the Great Recession had little effect on the unemployment rate. Look at the graphs for Austria, Belgium, Germany and the Netherlands. At the other end are Slovakia and especially Estonia, where unemployment increased a lot, but started falling quickly.
3. The five countries that received EU help (Cyprus, Greece, Ireland, Portugal and Spain) all recorded very high increases in unemployment. Ireland seems to be past the worst period; the others are not.
4. The last time any country had a budget surplus was in 2008; since then every country except Estonia has been running a deficit. Deficits in some countries are absurd. The Irish government guaranteed bank debt and had a deficit of over 30% in 2010. Greece, Spain and UK seem to be basket cases.
5. Under the Maastricht treaty that created the Euro, debt to GDP ratio should be under 60%. Belgium, Greece and Italy have never reached that limit. In most countries it is now above 60%
6. Finally, look at two countries that are in good shape: Finland and Estonia. They have no debt or deficit problem. Estonia went through a wrenching recession but recovered remarkably well. Two years ago its unemployment rate was the highest after Spain; now it is less than a half of Spanish rate. Finland also went through a deep recession. Note that both countries have relatively high rates of unemployment.
Thursday 1 November 2012
50. No end in sight part 2.
Record unemployment in Europe
Here is a simple comment on the situation in Europe: one small country (Greece) has done endless damage to the European economy.
How could the damage have been avoided? By running balanced budgets. A country which has a large deficit makes itself vulnerable to swings in credit markets.
Here is a simple comment on the situation in Europe: one small country (Greece) has done endless damage to the European economy.
How could the damage have been avoided? By running balanced budgets. A country which has a large deficit makes itself vulnerable to swings in credit markets.
49. No end in sight
of accusations of bankers' wrongdoing.
Now it is about manipulating California electricity markets.
Interestingly enough, the accusations now come with teeth:
"The FERC also said four of the company's power traders -- Daniel Brin, Scott Connelly, Karen Levine, and Ryan Smith -- have 30 days to show why they should not be assessed a total of $18 million in civil penalties."
The trades led to a profit of $35 million; the Federal Energy Regulatory Commission demands a fine equal to the ill-gottne profit (with interest) plus $435 million in civil penalties.
"Scary stuff," said one senior executive at a trading firm. "Which I guess is the point."
Now it is about manipulating California electricity markets.
Interestingly enough, the accusations now come with teeth:
"The FERC also said four of the company's power traders -- Daniel Brin, Scott Connelly, Karen Levine, and Ryan Smith -- have 30 days to show why they should not be assessed a total of $18 million in civil penalties."
The trades led to a profit of $35 million; the Federal Energy Regulatory Commission demands a fine equal to the ill-gottne profit (with interest) plus $435 million in civil penalties.
"Scary stuff," said one senior executive at a trading firm. "Which I guess is the point."
Tuesday 30 October 2012
47. Oops: things got a little out of hand
Here is how a UBS trader tries to explain how he lost $2.3bln
Everyone is guilty but him; he was just trying to recoup the money for the bank.
Everyone is guilty but him; he was just trying to recoup the money for the bank.
45. Fiscal cliff alarm
I have been telling you about the fiscal cliff for some time. Other people are starting to seriously worrying about it. An analysis from Reuters makes an interesting point about the output effects of government purchases and taxes. Until the Great recession, a one dollar of government cuts reduced output by only 50 cents. The reason was that, to stimulate economy, central banks would typically simultaneously lower interest rates. We will talk about in in more details when we discuss the IS-IC model in chapter 9.
But now interest rates are at or near zero and central banks cannot reduce them. In other words, when the fiscal cliff comes, central banks will not be able to stimulate the economy and a dollar government cut will reduce output by an estimated 0.9-1.7 dollars. The fiscal cliff involved a combination of tax increases and spending cuts of around 4% of US GDP. This means that the US economy, which is predicted to grow at 2% if the cuts are avoided, will shrink significantly.
But now interest rates are at or near zero and central banks cannot reduce them. In other words, when the fiscal cliff comes, central banks will not be able to stimulate the economy and a dollar government cut will reduce output by an estimated 0.9-1.7 dollars. The fiscal cliff involved a combination of tax increases and spending cuts of around 4% of US GDP. This means that the US economy, which is predicted to grow at 2% if the cuts are avoided, will shrink significantly.
Sunday 28 October 2012
46. Larry Fink is also worried about the fiscal cliff
At a conference organized by the Economist, the British magazine you should read, Larry Fink said that the fiscal cliff is the biggest problem facing the newly elected president.
Who is Larry Fink? You can read about him in this Vanity Fair article It is long so here is a synopsis. In 1988 he founded an asset management company which is now the largest in the world, managing almost 4 trillion dollars, around 5% of all managed funds.
But, according to Wikipedia, he is not a banker: "Larry Fink flies on commercial airlines.[..] Likewise, according to an interviewer, he takes the train rather than a private jet when he spends time at his 26-acre country estate in North Salem, New York."
Who is Larry Fink? You can read about him in this Vanity Fair article It is long so here is a synopsis. In 1988 he founded an asset management company which is now the largest in the world, managing almost 4 trillion dollars, around 5% of all managed funds.
But, according to Wikipedia, he is not a banker: "Larry Fink flies on commercial airlines.[..] Likewise, according to an interviewer, he takes the train rather than a private jet when he spends time at his 26-acre country estate in North Salem, New York."
Wednesday 24 October 2012
44. Civil and criminal cases
In the previous posting, all cases were civil, which means that shareholders will pay and nobody will go to jail.
Insider trading is treated differently. Mr Gupta is an immigrant from India who had a great career.Here is a fragment from Wikipedia: "Gupta is widely regarded as one of the first Indians to successfully break through the glass ceiling, as the first Indian-born CEO of a multinational corporation
Insider trading is treated differently. Mr Gupta is an immigrant from India who had a great career.Here is a fragment from Wikipedia: "Gupta is widely regarded as one of the first Indians to successfully break through the glass ceiling, as the first Indian-born CEO of a multinational corporation
43. Again? They will never let us leave in peace
in Greenwich, CT
And in banking news
1. Bank of America
2. Wells Fargo According to the lawsuit, they have been doing this for 10 years and nobody noticed.
3. They got Bank of America how BofA was forced to pay $2.4billion.
If you are thinking about a career in a growth industry, please skip this one:
“I can’t predict the next scandal,” Mr. Berger said. “But I know that fraud is a growth industry, and so is greed.”
And in banking news
1. Bank of America
2. Wells Fargo According to the lawsuit, they have been doing this for 10 years and nobody noticed.
3. They got Bank of America how BofA was forced to pay $2.4billion.
If you are thinking about a career in a growth industry, please skip this one:
“I can’t predict the next scandal,” Mr. Berger said. “But I know that fraud is a growth industry, and so is greed.”
42. Can't We All Be More Like Scandinavians?
A very interesting explanation of inequality is in this article:
Can't We All Be More Like Scandinavians? Asymmetric Growth and Institutions in an Interdependent World" It is written by some of the best economists - the first author will get a Nobel prize one day.
Here is the abstract:
In an interdependent world, could all countries adopt the same egalitarianism reward structures and institutions? To provide theoretical answers to this question, we develop a simple
model of economic growth in a world in which all countries benefit…t and potentially contribute
to advances in the world technology frontier. A greater gap of incomes between successful and
unsuccessful entrepreneurs (thus greater inequality) increases entrepreneurial effort and hence
a country’s contributions to the world technology frontier. We show that, under plausible assumptions, the world equilibrium is necessarily asymmetric: some countries will opt for a type of
“cutthroat” capitalism that generates greater inequality and more innovation and will become
the technology leaders, while others will free-ride on the cutthroat incentives of the leaders and
choose a more “cuddly”form of capitalism. Paradoxically, those with cuddly reward structures,
though poorer, may have higher welfare than cutthroat capitalists— but in the world equilibrium, it is not a best response for the cutthroat capitalists to switch to a more cuddly form of
capitalism. We also show that domestic constraints from social democratic parties or unions
may be beneficial for a country because they prevent cutthroat capitalism domestically, instead
inducing other countries to play this role.
An explanation in more accessible language:
As is the case with economists, they build a model. The model attempts to explain why some countries have cutthroat capitalism - see the previous posting - and some are more equal (for example Scandinavian countries). Main points:
There are two types of countries. Type A are unequal, with cut-throat capitalism (think US). Type B are more equal, with cuddly capitalism (think Scandinavian countries).
Clicking this link will download the article
Can't We All Be More Like Scandinavians? Asymmetric Growth and Institutions in an Interdependent World" It is written by some of the best economists - the first author will get a Nobel prize one day.
Here is the abstract:
In an interdependent world, could all countries adopt the same egalitarianism reward structures and institutions? To provide theoretical answers to this question, we develop a simple
model of economic growth in a world in which all countries benefit…t and potentially contribute
to advances in the world technology frontier. A greater gap of incomes between successful and
unsuccessful entrepreneurs (thus greater inequality) increases entrepreneurial effort and hence
a country’s contributions to the world technology frontier. We show that, under plausible assumptions, the world equilibrium is necessarily asymmetric: some countries will opt for a type of
“cutthroat” capitalism that generates greater inequality and more innovation and will become
the technology leaders, while others will free-ride on the cutthroat incentives of the leaders and
choose a more “cuddly”form of capitalism. Paradoxically, those with cuddly reward structures,
though poorer, may have higher welfare than cutthroat capitalists— but in the world equilibrium, it is not a best response for the cutthroat capitalists to switch to a more cuddly form of
capitalism. We also show that domestic constraints from social democratic parties or unions
may be beneficial for a country because they prevent cutthroat capitalism domestically, instead
inducing other countries to play this role.
An explanation in more accessible language:
As is the case with economists, they build a model. The model attempts to explain why some countries have cutthroat capitalism - see the previous posting - and some are more equal (for example Scandinavian countries). Main points:
There are two types of countries. Type A are unequal, with cut-throat capitalism (think US). Type B are more equal, with cuddly capitalism (think Scandinavian countries).
- the bigger the rewards to successful entrepreneurs, the greater is the incentive to innovate. This means that in type A countries there is more innovation.
- in type B countries rewards to successful entrepreneurs are smaller so those countries innovate less. Instead they adopt innovation from the type A countries.
- Type B countries are free-riding: they wait until a type A country invents something (which is expensive) and imitate it (which is cheaper).
- Type A countries are technological leaders and so are richer; type B countries are technological followers and so are poorer.
- But type B countries, while poorer, are more equal and so they are better off.
Clicking this link will download the article
41. Why they are talking so little about rising inequality
Over the last 10 years income inequality has been increasing in many countries, especially in the US. This NYT graphics shows the details. Median family income in the US has stagnated since around year 2000 (top panel). The change in median income over a 11-year long period (for example over 2000-2011) was, until 2008, always positive with the exception of a minimal drop in the 1981-82 recession. It has been negative in the last three years (middle panel).
The article discusses the reasons and is worth reading. Here I just provide a list:
But there is another explanation for which the article provides a graphic (bottom panel)
Almost all benefits of economic growth went to the rich (bottom panel). Since 1980: income of the top 0.01% tripled, of the top 0.1% more than doubled, for the top 1% increased by 64%. Median income increased by only 11%.
Of course income is interrelated with the above factors.
Think whether inequality is beneficial or detrimental to the economy. One answer in posting 42.
The article discusses the reasons and is worth reading. Here I just provide a list:
- digital revolution= education matters
- education - "US has lost its once-large global lead
- globalization which eliminated a lot of well-paying industrial jobs
- automation - also eliminated a lot of well-paying industrial jobs
- relative decline in earnings of low skilled workers - record earnings gap between college graduates and others;
- unemployment rates: 11.3% no high school, 8.7% high schoo graduates, 6.5% some college, 4.1% bachelor's degree
But there is another explanation for which the article provides a graphic (bottom panel)
Almost all benefits of economic growth went to the rich (bottom panel). Since 1980: income of the top 0.01% tripled, of the top 0.1% more than doubled, for the top 1% increased by 64%. Median income increased by only 11%.
Of course income is interrelated with the above factors.
Think whether inequality is beneficial or detrimental to the economy. One answer in posting 42.
Sunday 21 October 2012
40. Remeber Thelma and Louise?
You probably do not, because you are too young. It is a 1991 movie directed by Ridley Scott (of the Alien fame). Two women are on a run and they end up, on purpose, driving towards the Grand Canyon and (spoiler alert!) plunging to their deaths.
Now you will know what politicians mean when they say "we will avoid the Thelma and Louise ending". By the way, the film terminology is popular: the "fiscal clliff tax increases" are called Taxmageddon.
This article discusses the expiry of the payroll tax cut. American workers pay the tax at the rate of 6.2% of earnings up to $110 000. The tax has been temporarily reduced to 4.2%. Its extension is not likely as neither party has proposed it.
Now you will know what politicians mean when they say "we will avoid the Thelma and Louise ending". By the way, the film terminology is popular: the "fiscal clliff tax increases" are called Taxmageddon.
This article discusses the expiry of the payroll tax cut. American workers pay the tax at the rate of 6.2% of earnings up to $110 000. The tax has been temporarily reduced to 4.2%. Its extension is not likely as neither party has proposed it.
Thursday 18 October 2012
39. 25 years ago markets crashed
In this article the author describes what happened on October 19, 1987 and laments that people have been replaced by dumb computers. In normal times it works well, but when the going gets touch, high frequency traders abandon the market.
Of course we cannot end computerized trading any more than we can end using computers to type.
Of course we cannot end computerized trading any more than we can end using computers to type.
Wednesday 17 October 2012
38. Michael Spence interview
I have just come across an interview with Michael Spence in the Wall Street Journal. It is 12 minutes long. This is the first time I am including video in the blog. Why?
but simply that was he says is very sensible. Enjoy
- not because he explained why people go to university (to signal ability in the job market - Job Market Signaling)
- not because he got a Nobel Prize in Economics (2001)
- not because he was the Dean of the Arts and Science faculty at Harvard and Dean of the Stanford Business School
but simply that was he says is very sensible. Enjoy
36. Central Bank transparency
It used to be that central bankers were very secretive. It stemmed from their desire to be seen as infallible. Reputation of the Central Bank, so the thinking went, required that the bank was never wrong. The best way to make sure you are never wrong is to say nothing.
In recent years central banks became more transparent. The new thinking is that the best working market is a market that is well informed. Providing rationale behind policy decisions, and improving communication in general, is seen as an important tool of monetary policy (Professor Pierre Siklos of WLU has written on this issue extensively; you may want to take a course from him in the future).
Nowadays central banks publish reports which provide insights into their thinking. The also publish minutes from the meetings of the interest - setting body.
Another innovation is disclosing disagreement between the members of the policy - setting body. In the minutes of the October 4, 2012 meeting, the Bank of England reports that "There were some differences of view between members (my underline) about the outlook and the likelihood that further easing in policy would be required"
You can find the report here. The statement cited above is on p. 9.
The Federal Reserve Board held a meeting on the same day. Its report also mentions disagreement. It is more transparent than the Bank of England:it names members who voted for and who voted against.
In recent years central banks became more transparent. The new thinking is that the best working market is a market that is well informed. Providing rationale behind policy decisions, and improving communication in general, is seen as an important tool of monetary policy (Professor Pierre Siklos of WLU has written on this issue extensively; you may want to take a course from him in the future).
Nowadays central banks publish reports which provide insights into their thinking. The also publish minutes from the meetings of the interest - setting body.
Another innovation is disclosing disagreement between the members of the policy - setting body. In the minutes of the October 4, 2012 meeting, the Bank of England reports that "There were some differences of view between members (my underline) about the outlook and the likelihood that further easing in policy would be required"
You can find the report here. The statement cited above is on p. 9.
The Federal Reserve Board held a meeting on the same day. Its report also mentions disagreement. It is more transparent than the Bank of England:it names members who voted for and who voted against.
Tuesday 16 October 2012
35. Who do they think they are? Bankers?
Some background. A newspaper belonging to the Rupert Murdoch media empire, News of the World, was a typical tabloid, similar in many respects to the National Enquirer (i.e. not really news, but revelations about important people). Its journalists hacked into phones of various important people to obtain information they later printed. They also paid police for information. Both actions were illegal in British law. When this came out, the CEO of the British arm of the Murdoch Empire, Rebekah Brooks, resigned. She is being prosecuted for her actions related to the affair. Now it turns out that she got a parting gift of $10mln.
Bottom line - not only bankers do what they can get away with.
Interesting note: Rebekah Brooks joined News of the World as a secretary in 1989 when she was 20. Never finished university. By 2000 she was the editor. Apparently she was very ambitious. Great career, as long as laws are not broken.
34. Household debt and monetary policy
Monetary policy, as we teach it, is not affected by the level of household debt. Turns out we should be teaching something different. Bank of Canada Governor says the bank may react to the high level of household debt in Canada by raising interest rates.
There is no straightforward way of incorporating household debt into monetary policy. The reason for the statement is the concern that debt is getting too high, creating risks in the economy. As the mandate of the Bank of Canada is to maintain inflation rate around 2%, household debt should not matter. But apparently it does.
What this means is that the Bank of Canada, in its conduct of monetary policy, learned some lessons from the Great Recession (or, more precisely, the prelude to the great recession) and is now going to react to bubbles.
There is no straightforward way of incorporating household debt into monetary policy. The reason for the statement is the concern that debt is getting too high, creating risks in the economy. As the mandate of the Bank of Canada is to maintain inflation rate around 2%, household debt should not matter. But apparently it does.
What this means is that the Bank of Canada, in its conduct of monetary policy, learned some lessons from the Great Recession (or, more precisely, the prelude to the great recession) and is now going to react to bubbles.
33. Economy - bad
according to OECD chief
- in particular youth unemployment is a problem
- income inequality is the highest in 30 years
- five years after the beginning of the crisis the OECD countries are stuck with low growth and high unemployment.
- growth in the OECD countries will fall in the next year
Monday 15 October 2012
32. Regulating banks (for EC223)
A big problem that arose from the Great Recession is what to do with large banks. A failure of a large bank (think Lehman Brothers) can cause considerable damage to the world economy. Some banks were deemed too big to fail: their failure would have caused catastrophic damage to the world economy.
What does being "too big to fail" mean? It means that, if such bank runs into problems it will be rescued by the government (as, for example, happened with Citigroup, Nexia and RBC). These banks have therefore an implicit guarantee from the government. This makes them safer than other banks and lowers their cost of capital. If unregulated competition was allowed, these banks would be more profitable and will buy up smaller banks, reducing competition. Eventually, in effect, the taxpayers would provide a blanket guarantee to the banking system.
To prevent that, G20 endorsed proposals to increase supervision and capital requirements of the "too big to fail" banks. The proposal dealt with the largest banks that were "systematically important" on the world scale.
The article reports that the Basel Committee on Banking Supervision, of which Canada is a member, recommends to extend the regulations to a second tier banks: "domestic systematically important banks". These recommendations will likely cover 5biggest Canadian banks (they may also include the National Bank of Canada which is much smaller than the top five, but is much bigger than any other bank.
What does being "too big to fail" mean? It means that, if such bank runs into problems it will be rescued by the government (as, for example, happened with Citigroup, Nexia and RBC). These banks have therefore an implicit guarantee from the government. This makes them safer than other banks and lowers their cost of capital. If unregulated competition was allowed, these banks would be more profitable and will buy up smaller banks, reducing competition. Eventually, in effect, the taxpayers would provide a blanket guarantee to the banking system.
To prevent that, G20 endorsed proposals to increase supervision and capital requirements of the "too big to fail" banks. The proposal dealt with the largest banks that were "systematically important" on the world scale.
The article reports that the Basel Committee on Banking Supervision, of which Canada is a member, recommends to extend the regulations to a second tier banks: "domestic systematically important banks". These recommendations will likely cover 5biggest Canadian banks (they may also include the National Bank of Canada which is much smaller than the top five, but is much bigger than any other bank.
31. Household wealth and debt
On Monday Statistics Canada published revised National Balance Sheet accounts. The revision is technical; I will just point out some numbers:
National wealth: $6 805 billion
Net foreign debt: $ 277 billion
National net worth (difference between the two) $6 529 trillion, or about 4 times GDP
National net worth per person: $188 300 (remember it as around $200 000)
Big problem: household debt. It was, as percentage of disposable income:
This is not a big problem at present. Household debt service ratio (debt payments to disposable income) is close to historical lows since the interest rates are low.
But the ratio of debt to net worth increased significantly as the result of the Great Recession:
If, as it is quite likely, the "fiscal cliff" is not resolved, the US economy will go into a recession next year, dragging us along. In a recession households will "deleverage" (reduce their debt).
Deleveraging takes time and so consumption will be low for a long time, prolonging the recession.
National wealth: $6 805 billion
Net foreign debt: $ 277 billion
National net worth (difference between the two) $6 529 trillion, or about 4 times GDP
National net worth per person: $188 300 (remember it as around $200 000)
Big problem: household debt. It was, as percentage of disposable income:
- 87% in 1990
- 141% in 2007 (before the start of the Great Recession
- 162% in 2011
This is not a big problem at present. Household debt service ratio (debt payments to disposable income) is close to historical lows since the interest rates are low.
But the ratio of debt to net worth increased significantly as the result of the Great Recession:
- from 1990 to 2007 it was between 18.4% and 21%
- from 2008 on it was over 24%.
If, as it is quite likely, the "fiscal cliff" is not resolved, the US economy will go into a recession next year, dragging us along. In a recession households will "deleverage" (reduce their debt).
Deleveraging takes time and so consumption will be low for a long time, prolonging the recession.
Sunday 14 October 2012
30. Extra! Extra! Chinese exchange rate
set mostly by markets , says the head of China's Central Bank.
This is more politics than anything else: Republicans want to call China a "currency manipulator"; this would involve restrictions of foreign trade.
This is more politics than anything else: Republicans want to call China a "currency manipulator"; this would involve restrictions of foreign trade.
29. And one more article making a fundamental error
Statistics Canada revised data on labour productivity in the business sector to bring them in line with international standards.The revised data show that Canadian productivity was lower than previously thought.
How much? It is difficult to say since the author confuses levels with rates of growth. Read the following fragment:
"The result means business sector labour productivity was an average of 0.1 per cent lower per year from 1981 to the second quarter of this year."
Big deal, you think. 0.1%, or 1/1000 lower is not much. But in the next sentence he writes: "The largest impact was in the years 1981 to 1990, when productivity growth was revised down by 0.3 per cent per year – to 1 per cent from 1.3 per cent."
So he really means productivity growth. But you would not guess it from what he writes.
You should read the article and find other places where the writing is vague.
Note that the Statistics Canada report is precise in its language: "The combined result of the revisions to gross domestic product (GDP) and hours worked was an average 0.1 percentage point decrease in the annual growth rate of labour productivity in the business sector over the three decades between 1981 and 2011."
How big is the overall correction to productivity? Not very big. (Click on description for chart 4 to see actual data). According to original data, between Q1 1981 and Q2 2012 productivity increased by 49.27%; according to new data, by 48.32%.
So the article is not only misleading but also is about a small change.
How much? It is difficult to say since the author confuses levels with rates of growth. Read the following fragment:
"The result means business sector labour productivity was an average of 0.1 per cent lower per year from 1981 to the second quarter of this year."
Big deal, you think. 0.1%, or 1/1000 lower is not much. But in the next sentence he writes: "The largest impact was in the years 1981 to 1990, when productivity growth was revised down by 0.3 per cent per year – to 1 per cent from 1.3 per cent."
So he really means productivity growth. But you would not guess it from what he writes.
You should read the article and find other places where the writing is vague.
Note that the Statistics Canada report is precise in its language: "The combined result of the revisions to gross domestic product (GDP) and hours worked was an average 0.1 percentage point decrease in the annual growth rate of labour productivity in the business sector over the three decades between 1981 and 2011."
How big is the overall correction to productivity? Not very big. (Click on description for chart 4 to see actual data). According to original data, between Q1 1981 and Q2 2012 productivity increased by 49.27%; according to new data, by 48.32%.
So the article is not only misleading but also is about a small change.
28. Support for teaching you mental arithmetics.
This is from the Business section of the Globe and Mail, May 18, 2006, page B10
27. Support for doing the readings I discuss in class
The Globe and Mail has published a series on higher education. On Saturday it asked:
Here is one of the answers:
“Every student graduating from college or university should be capable of doing a critical assessment of an article or editorial they read in the newspaper. If they can't do this, how can they be informed and contributing members of their communities and workplaces and how will they be able to make the myriad of informed decisions they will be asked to make throughout their lives?” Harvey Weingarten, president of the Higher Education Quality Council of Ontario
Here is one of the answers:
“Every student graduating from college or university should be capable of doing a critical assessment of an article or editorial they read in the newspaper. If they can't do this, how can they be informed and contributing members of their communities and workplaces and how will they be able to make the myriad of informed decisions they will be asked to make throughout their lives?” Harvey Weingarten, president of the Higher Education Quality Council of Ontario
Monday 8 October 2012
26. On exchange rates
The Economist has published an interesting article on exchange rates.
Treat it as the first test of your understanding of what a good economic publication writes.
It is a difficult test as, so far, we discussed many relevant issues only in the blog, and not in the course.
We will return to this article later in the course
Treat it as the first test of your understanding of what a good economic publication writes.
It is a difficult test as, so far, we discussed many relevant issues only in the blog, and not in the course.
We will return to this article later in the course
24. IMF thinks growth will be slow for a significant amount of time
IMF chief economist Olivier Blanchard, who will visit Waterloo in November, discussed the IMF report on world economy. IMF is predicting slower growth than it did in July. There is a general feeling of uncertainty and Blanchard is concerned that the slow growth will continue.
Wednesday 3 October 2012
23. End of Growth?
As it happens, two well-known authors are coming to Laurier to talk about the end of growth.
Want to know the future? It will cost you ($15).
Suzuki will likely talk about the environment, Rubin is anyone's guess.
Want to know the future? It will cost you ($15).
Suzuki will likely talk about the environment, Rubin is anyone's guess.
22. Growth over?
A prominent economist, Robert Gordon from Northwestern, wrote a paper suggesting growth in the US may be over. By extension, this would also mean the end of growth in other developed countries (but not in China, India and other developing countries).
Economic growth, as we know it, is due to innovation.The paper looks at big waves of innovation (industrial revolutions): IR1 (steam and railroads, 1750-1830), IR2 (electricity, internal combustion engine, running water, indoor toilets, communications, entertainment, chemicals, petroleum, 1870-1900) and IR3 (computers, the web, mobile phones). He argues that the second industrial revolution was most important, and since its effects spread throughout the world (for example cars, air travel, good hygiene) the potential for future innovation is not as high.
He also argues that even if the pace of innovation has not decreased, there are six factors that would slow economic growth in the US in the future. Here is their list, with the contribution, in his opinion, to the slowdown in the rate of economic growth for the bottom 99% of the US population:
Without slowdown - assume that growth continues at the rate of 1.8%, the 1987-2007 average. Note that the Great Recession is not taken into account - rightfully so as it would dominate the numbers. The Great Recession is an unusually severe, one time (hopefully) event and so should not be included in discussion of long-term growth
Slowdown factors and how much they will reduce the growth rate (in percentage points):
Gordon does not say it will happen, nor does he say his estimates are precise. He treats the estimates as a thought-provoking warning.
For Canada, factors 1,2, 4 and environment are similar; inequality has risen slower than in the US; we benefit from higher energy prices since we are an exporter; our consumer debt is higher and government debt is lower. So perhaps the effect on Canadian growth would be smaller, but not much smaller.
This is a long paper which you can download at the university from NBER. For your convenience I copy the abstract below.
If you do not want to read the whole paper, from this address you can download a long summary;
A shorter summary with graphs is here.
A much shorter summary by a well known Financial Times writer (with his opinion) is here.
Economic growth, as we know it, is due to innovation.The paper looks at big waves of innovation (industrial revolutions): IR1 (steam and railroads, 1750-1830), IR2 (electricity, internal combustion engine, running water, indoor toilets, communications, entertainment, chemicals, petroleum, 1870-1900) and IR3 (computers, the web, mobile phones). He argues that the second industrial revolution was most important, and since its effects spread throughout the world (for example cars, air travel, good hygiene) the potential for future innovation is not as high.
He also argues that even if the pace of innovation has not decreased, there are six factors that would slow economic growth in the US in the future. Here is their list, with the contribution, in his opinion, to the slowdown in the rate of economic growth for the bottom 99% of the US population:
Without slowdown - assume that growth continues at the rate of 1.8%, the 1987-2007 average. Note that the Great Recession is not taken into account - rightfully so as it would dominate the numbers. The Great Recession is an unusually severe, one time (hopefully) event and so should not be included in discussion of long-term growth
Slowdown factors and how much they will reduce the growth rate (in percentage points):
- baby boomer retirement: -0.2%
- slower progress in educational attainment (it is already very high): - 0.2%
- rising inequality: - 0.5% (he assumes that income inequality will continue to increase at the the same rate as in the past, lowering growth for the bottom 99%)
- globalization: -0.2% (more outsourcing, fewer good middle class jobs)
- energy prices and environmental costs: - 0.2%
- effect of high consumer and government debts: -0.3%
Gordon does not say it will happen, nor does he say his estimates are precise. He treats the estimates as a thought-provoking warning.
For Canada, factors 1,2, 4 and environment are similar; inequality has risen slower than in the US; we benefit from higher energy prices since we are an exporter; our consumer debt is higher and government debt is lower. So perhaps the effect on Canadian growth would be smaller, but not much smaller.
This is a long paper which you can download at the university from NBER. For your convenience I copy the abstract below.
If you do not want to read the whole paper, from this address you can download a long summary;
A shorter summary with graphs is here.
A much shorter summary by a well known Financial Times writer (with his opinion) is here.
Robert J. Gordon
This paper raises basic questions about the process of economic growth.
It questions the assumption, nearly universal since Solow’s seminal
contributions of the 1950s, that economic growth is a continuous process
that will persist forever. There was virtually no growth before 1750,
and thus there is no guarantee that growth will continue indefinitely.
Rather, the paper suggests that the rapid progress made over the past
250 years could well turn out to be a unique episode in human history.
The paper is only about the United States and views the future from 2007
while pretending that the financial crisis did not happen. Its point
of departure is growth in per-capita real GDP in the frontier country
since 1300, the U.K. until 1906 and the U.S. afterwards. Growth in this
frontier gradually accelerated after 1750, reached a peak in the middle
of the 20th century, and has been slowing down since. The paper is
about “how much further could the frontier growth rate decline?”
The
analysis links periods of slow and rapid growth to the timing of the
three industrial revolutions (IR’s), that is, IR #1 (steam, railroads)
from 1750 to 1830; IR #2 (electricity, internal combustion engine,
running water, indoor toilets, communications, entertainment, chemicals,
petroleum) from 1870 to 1900; and IR #3 (computers, the web, mobile
phones) from 1960 to present. It provides evidence that IR #2 was more
important than the others and was largely responsible for 80 years of
relatively rapid productivity growth between 1890 and 1972. Once the
spin-off inventions from IR #2 (airplanes, air conditioning, interstate
highways) had run their course, productivity growth during 1972-96 was
much slower than before. In contrast, IR #3 created only a short-lived
growth revival between 1996 and 2004. Many of the original and spin-off
inventions of IR #2 could happen only once – urbanization,
transportation speed, the freedom of females from the drudgery of
carrying tons of water per year, and the role of central heating and air
conditioning in achieving a year-round constant temperature.
Even
if innovation were to continue into the future at the rate of the two
decades before 2007, the U.S. faces six headwinds that are in the
process of dragging long-term growth to half or less of the 1.9 percent
annual rate experienced between 1860 and 2007. These include
demography, education, inequality, globalization, energy/environment,
and the overhang of consumer and government debt. A provocative
“exercise in subtraction” suggests that future growth in consumption per
capita for the bottom 99 percent of the income distribution could fall
below 0.5 percent per year for an extended period of decades.
Monday 1 October 2012
21. I do try to use our sources
but the charges were apparently not worth the Globe's attention (the National Post did, but the article does not provide details). Instead, they chose to reprint a crazy, stupid article from Reuters. The author of the article is worried that current monetary policy is not effective in increasing consumption and suggests that "Instead of printing money to buy bonds, the Fed could print money to
give to citizens." She says that "The suggestion is not as crazy as it might seem."
Indeed, it is much crazier.
Ask yourself the following question: what would happen if the central bank printed money and gave it directly to households? Who will if provide work for?
Answer: the printer. Also the paper maker and the ink producer, as well as the distributors of the cash.
Printing free newspapers will be more effective.
Indeed, it is much crazier.
Ask yourself the following question: what would happen if the central bank printed money and gave it directly to households? Who will if provide work for?
Answer: the printer. Also the paper maker and the ink producer, as well as the distributors of the cash.
Printing free newspapers will be more effective.
20. Extra! Extra!
Wow! (but no jail: these are civil suits)
Here is what happened. In 2005-7 the investment bank Bear Stearns sold mortgage-backed securities to investors. The accusation is that "The firms made material misrepresentations about the quality of the
loans in the securities [...] and ignored evidence of broad
defects among the loans that they pooled and sold to investors".
Another accusation is that they double dipped: Suit says Bear Stearns double dipped with mortgage bonds .
Here is how it worked:
1. A loan originator (a bank) would give mortgage to a borrower.
2. Bear Stearns would buy many such mortgages from loan originators, package them into securities and sell them to investors.
3. The purchase contract between Bear Stearns and the loan originator included a clause that, if a mortgage was defaulted within a short time after Bear Stearns bought it, the loan originator would compensate Bearn Stearns for losses.
This makes sense since the loan originator knew the borrower, Bear Stearns did not.
4. And so they did. Bearn Stearns received substantial amounts of compensation. It did not pass it on to investors. They are now suing.
Apparently this was a fairly common practice
Here it is in more familiar terms:
- you buy, say, electronic parts. The sellers promise to pay you a fine if they are defective.
- you sell a box of parts, claiming they are in perfect order.
- the sellers let you know that the parts were, in fact, defective and pay fines.
- you do not pass on the money to the buyer of the box of parts, but keep them.
So the buyer of box of parts pays you for good parts, and the seller of the parts pays you because they are defective. Your company makes a profit and you get a bonus, and buy yourself a car, much, much better than the one in the familiar song...
Nice deal if you can get it and get away with it.
19. The real wage
Today we will discuss real wages. Here are some data on, well, a student's? real wage
If the link does not work, Google: How long does it take to afford a beer?
If the link does not work, Google: How long does it take to afford a beer?
Friday 28 September 2012
18. These pesky numbers
In the article in post 17 they state, correctly, that Bank of America Acquired Merill Lynch for $50bln. Yet the articles about the recent settlement (including that in post 16) say it was a $20 billion deal. I do not know why.
17. Legal issues in bank settlements
A few of you asked me why nobody went to jail after the Great Recession. Defer this question to your law class. Here is an article that has some information on the legal issues involved.
16. More on the Bank of America-Merill Lynch problem
In post 3 I described the issues around the takeover of Merill Lynch by the Bank of America. Shareholders who approved it were not told in advance about Merill Lynch colossal losses, nor about the promised bonus payments to Merill Lynch executives. The post was about the settlement with the Securities and Exchange Commission (SEC): $150million.
Now Bank of America agreed to pay $2.43billion to settle a class auction lawsuit from investors.
As usual, they deny they did anything wrong.It "said that it agreed to the settlement to get rid of the uncertainties, burden and costs related to the lawsuit." (see the link).
That is some uncertainty.
Now Bank of America agreed to pay $2.43billion to settle a class auction lawsuit from investors.
As usual, they deny they did anything wrong.It "said that it agreed to the settlement to get rid of the uncertainties, burden and costs related to the lawsuit." (see the link).
That is some uncertainty.
Wednesday 26 September 2012
15. The happiest OECD countries
Today we will talk to an alternative to GDP: measuring happiness. Here is a list of the happiest developed countries in the world. (from OECD).
Note that the article is misleading in what it says about debt of happiest countries. Norway indeed has a huge surplus, but this is unique. Norway gets significant income from North Sea Oil. Most of it is saved to provide funds in the future, when oil ends.
This is an example of a country trying to maintain constant consumption over time, just as individuals do (we will discuss this in chapter 4).
Note that the article is misleading in what it says about debt of happiest countries. Norway indeed has a huge surplus, but this is unique. Norway gets significant income from North Sea Oil. Most of it is saved to provide funds in the future, when oil ends.
This is an example of a country trying to maintain constant consumption over time, just as individuals do (we will discuss this in chapter 4).
14. No end in sight to the sovereign debt crisis
A couple of weeks ago the European Central Bank (ECB) announced that it will be buying bonds of Spain and Italy in order to reduce their cost of borrowing. Markets took it as a sign the worst has passed. But the respite did not last. Greeks went on strike, there was violence in Spain over austerity measures and the Bank of Spain predicts difficult time ahead.
As I said at the beginning of the course, the sovereign debt crisis will not go away any time soon.
As I said at the beginning of the course, the sovereign debt crisis will not go away any time soon.
13. How long will the effects of housing crash last?
Until 2023
This is when, according to a recent prediction, US house prices will reach the pre-crisis level.
This is when, according to a recent prediction, US house prices will reach the pre-crisis level.
12. Tertiary education
OECD has just published a report on tertiary education. Here are 10 most educated countries. Countiries are ranked by the proportion of adult population (25-64) with a tertiary degree.
There is a link in the article to the report. All 560 pages of it. Sorry, 570. The relevant table is on page 34.
Canada is #1.
Canada has by far the largest proportion of people with 2-year college education: 24%. Only in Belgium and Japan the proportion is over 16%. In the US it is 10%.
The countries with the highest proportion of population with university education is Norway (34%) followed by Israel and US (30%). Canada is 8th (26%).
There is a link in the article to the report. All 560 pages of it. Sorry, 570. The relevant table is on page 34.
Canada is #1.
Canada has by far the largest proportion of people with 2-year college education: 24%. Only in Belgium and Japan the proportion is over 16%. In the US it is 10%.
The countries with the highest proportion of population with university education is Norway (34%) followed by Israel and US (30%). Canada is 8th (26%).
Monday 24 September 2012
11. Falling off the fiscal cliff
If nothing changes, on January 2 the US will start reducing both civilian and military spending, and taxes will increase.
How did it come to that? In 2011a bipartisan commission was created to reduce the deficit. The commission had equal number of members of both parties. As inducement to come to an agreement, both military and civilian spending were to be cut significantly from 2013 on if no agreement is reached. In the end members voted according to party lines and, indeed, there was no agreement.
The main increase in taxes is due to expiration of the extension of tax cuts introduced by Bush in 2001. They were extended two years ago as the parties could not come to an agreement beyond moving the problem past the presidential election. This is called"kicking the can down the road. Read about it here.There are several other laws that will raise taxes next year.
Bottom line: the US political system became dysfunctional and is unable to make difficult decisions.
So far Canada has not suffered, except for the overvalued Canadian dollar. But if shares in the US fall by 20% as Goldman Sachs predicts, Canadian stocks will fall as well. US economy may fall into a recession if nothing is done; as the Canadian economy is not in great shape, it may follow.
How did it come to that? In 2011a bipartisan commission was created to reduce the deficit. The commission had equal number of members of both parties. As inducement to come to an agreement, both military and civilian spending were to be cut significantly from 2013 on if no agreement is reached. In the end members voted according to party lines and, indeed, there was no agreement.
The main increase in taxes is due to expiration of the extension of tax cuts introduced by Bush in 2001. They were extended two years ago as the parties could not come to an agreement beyond moving the problem past the presidential election. This is called"kicking the can down the road. Read about it here.There are several other laws that will raise taxes next year.
Bottom line: the US political system became dysfunctional and is unable to make difficult decisions.
So far Canada has not suffered, except for the overvalued Canadian dollar. But if shares in the US fall by 20% as Goldman Sachs predicts, Canadian stocks will fall as well. US economy may fall into a recession if nothing is done; as the Canadian economy is not in great shape, it may follow.
Wednesday 19 September 2012
10. QE in Japan
The Japanese economy has been in and out of recession since 1989. Interest rates are among the lowest in the world. So the Bank of Japan followed the FED and announced an increase in its QE : the amount of bond purchases has been increased from 70 to 80 tr yen (by about $125bln).
Do not pay attention to the currency problem mentioned in the article; it is a red herring. Japanese Yen has appreciated in recent years; its depreciation is needed by the Japanese industry and will not surprise anyone, nor will it invite retaliation.
Do not pay attention to the currency problem mentioned in the article; it is a red herring. Japanese Yen has appreciated in recent years; its depreciation is needed by the Japanese industry and will not surprise anyone, nor will it invite retaliation.
9. Errors
As you may have noticed, I tend to show you various errors so that you do not make them in the future. In a commentary to the Statistics Canada report discussed in the previous post, Canadian Business makes two mistakes that are instructive. They provide the dollar estimates of the underground economy ($18.8 billion in 1992 and $35.7 billion in 2008). These numbers are meaningless, since they are in current, and not in constant dollars.
Canadian business estimates what would have happened if all the underground activities had been taxed and all extra proceeds were used to reduce the deficit. This is naive: government spending does depend on its revenue. So the assumption that all the extra revenue would have been saved by the government is incorrect.
This type of reasoning is quite common. Something changes and the writer assumes all the effects fall on one thing only. But the economy is an interconnected system; if one thing changes, a lot of others do as well.
Canadian business estimates what would have happened if all the underground activities had been taxed and all extra proceeds were used to reduce the deficit. This is naive: government spending does depend on its revenue. So the assumption that all the extra revenue would have been saved by the government is incorrect.
This type of reasoning is quite common. Something changes and the writer assumes all the effects fall on one thing only. But the economy is an interconnected system; if one thing changes, a lot of others do as well.
8. Underground economy
In this and the next lecture we will be discussing GDP. One of the things not included in GDP is the underground economy. Globe and Mail reported on 19/9/2012 that most Canadians have paid under the table to avoid taxes. No surprise there. The article references a Statistics Canada report (the link in the paper is bad; to find the report Google: Estimating the Underground Economy in Canada, 1992-2008, click on the www.carpenters.org link - it is from the United Brotherhood of Carpenters - now, that is funny: why would carpenters read a report on paying under the table?). Big surprise here: the underground economy in Canada is only 2.2% of GDP. The estimates I have seen are much higher. An IMF article, provides estimates for 1990 using several methods; for Canada the size of the underground economy is between 10% and 13.5%, depending on the method. The difference may be due to the fact that the Statistics Canada report does not include illegal activities.
4.The effect of iphone5 on US GDP
I repeat here for your convenience the posting from mylearningspace. We talked about it last Thursday; I have updated it by what I have learned since then.
The calculation was not a journalistic mistake, as I thought. It was made by the chief economist of JP Morgan, the largest US bank. Here it is. I wrote to him and got an answer that is cited below.
1. Here is the calculation. Mr. Feroli, the chief economist, expects that 8 million of iphones 5 will be sold in the US in the 4th quarter. He thinks the price will be $600, of which $200 will be imported (they call it "imported cost component" , a typical gibberish of financial analysts). In economics we say that,in the production of iphone, $200 is produced outside of the US (and so does not count as US GDP) and $400 is produced in the US (and so counts in US GDP). The value of the portion of iphones produced in the US is 8 million times $400 = $3.2billion in a quarter, or $12.8bln in a year. Somehow this becomes 0.33% of US GDP. This is not correct. The US GDP is around $15 trillion so iphone5 contribution to US GDP is a bit less than 0.1%.
2. Should the analyst subtract the number of iphones 4 sold in the 4th quarter of 2011? Of course he should. The contribution to growth is not the level of production, but the change in the level of production.
What is going on? Hard to say. I actually have not seen anything like it before. Everyone made the same mistake, including a Nobel Prize winner Paul Krugman (it is clear from what he writes that he did not check the calculations).
It is a good example of the need to check what you read.
As business students you should be numerate.
*********************
Here is more on this topic. I wrote to Mr. Feroli that I have difficulty replicating his calculations. By my calculations, to increase growth by 0.33% of GDP, i.e. $12 450bln = 0.33% * $3 773bln (US GDP per quarter was, according to IMF, 15 090bln/4=3 773bln), the sales of iphones must be higher by 31 million =$12 450bln/$400 in Q4 2012 than in Q4 2011.
His reply: "Our apple analyst is of the belief that price-cutting on the 4 and 4s will actually lead to some increase in sales of previous generations"
That cannot explain the effect.
Writing this I realized what went wrong. I suspect the following:
JP Morgan took the value of GDP in 2011 ($15 090bln or $3 773bln a quarter),
added 3% for growth of nominal GDP and obtained, for Q4 2012, $3 885bln,
for some reason they divided this by 4 again, obtaining $971bln,
they calculated the value of the iphones produced in the quarter: $400*8 mln =$3.2bln,
dividing $3.2bln by $971bln they got 0.33%.
So there were two mistakes:
1. they got confused by quarters and years
2. they forgot that growth means the difference between this year and last, and calculated not extra growth, but extra GDP.
Well, do not laugh at them. As I wrote, every news organization, plus a Nobel laureate, copied it without noticing the error. Let us call it the Apple Awe
Two definitions of the word awe:
I am not sure where the 8 million estimate for Q4 2012 came from.
The calculation was not a journalistic mistake, as I thought. It was made by the chief economist of JP Morgan, the largest US bank. Here it is. I wrote to him and got an answer that is cited below.
1. Here is the calculation. Mr. Feroli, the chief economist, expects that 8 million of iphones 5 will be sold in the US in the 4th quarter. He thinks the price will be $600, of which $200 will be imported (they call it "imported cost component" , a typical gibberish of financial analysts). In economics we say that,in the production of iphone, $200 is produced outside of the US (and so does not count as US GDP) and $400 is produced in the US (and so counts in US GDP). The value of the portion of iphones produced in the US is 8 million times $400 = $3.2billion in a quarter, or $12.8bln in a year. Somehow this becomes 0.33% of US GDP. This is not correct. The US GDP is around $15 trillion so iphone5 contribution to US GDP is a bit less than 0.1%.
2. Should the analyst subtract the number of iphones 4 sold in the 4th quarter of 2011? Of course he should. The contribution to growth is not the level of production, but the change in the level of production.
What is going on? Hard to say. I actually have not seen anything like it before. Everyone made the same mistake, including a Nobel Prize winner Paul Krugman (it is clear from what he writes that he did not check the calculations).
It is a good example of the need to check what you read.
As business students you should be numerate.
*********************
Here is more on this topic. I wrote to Mr. Feroli that I have difficulty replicating his calculations. By my calculations, to increase growth by 0.33% of GDP, i.e. $12 450bln = 0.33% * $3 773bln (US GDP per quarter was, according to IMF, 15 090bln/4=3 773bln), the sales of iphones must be higher by 31 million =$12 450bln/$400 in Q4 2012 than in Q4 2011.
His reply: "Our apple analyst is of the belief that price-cutting on the 4 and 4s will actually lead to some increase in sales of previous generations"
That cannot explain the effect.
Writing this I realized what went wrong. I suspect the following:
JP Morgan took the value of GDP in 2011 ($15 090bln or $3 773bln a quarter),
added 3% for growth of nominal GDP and obtained, for Q4 2012, $3 885bln,
for some reason they divided this by 4 again, obtaining $971bln,
they calculated the value of the iphones produced in the quarter: $400*8 mln =$3.2bln,
dividing $3.2bln by $971bln they got 0.33%.
So there were two mistakes:
1. they got confused by quarters and years
2. they forgot that growth means the difference between this year and last, and calculated not extra growth, but extra GDP.
Well, do not laugh at them. As I wrote, every news organization, plus a Nobel laureate, copied it without noticing the error. Let us call it the Apple Awe
Two definitions of the word awe:
- From Wikipedia: Awe is an emotion comparable to wonder but less joyous, and more fearful or respectful.
- From dictionary.reference.com: an overwhelming feeling of reverence, admiration, fear, etc., produced by that which is grand, sublime, extremely powerful, or the like: in awe of God; in awe of ...
I am not sure where the 8 million estimate for Q4 2012 came from.
7. Why the US economy is weak
A typical recession lasts about a year and its followed by rapid expansion as firms rebuild inventories and consumers make up for delayed purchases. But not in the Great Recession. The rapid expansion never came, unemployment is still significantly higher than before the recession and the US economy is weak. Why? Because it is a financial recession brought about by housing and spending boom. US households are saving to reduce their debts (they are deleveraging and consumer spending is weak. Since consumer spending is about 2/3 of US economy, without growing consumption the economy is sluggish.
Monday 17 September 2012
6. Non-recourse loans
Today we will be talking about one reason so many US households defaulted on their loans: in the US, the loans are non-recourse. The loan is secured by property only and the lender cannot take over other assets of a defaulting household. The only penalty then is a bad credit rating. In Wednesday's New York Times there is an article that provides details. Some defaulting households can get another mortgage after as little as 2 years.
In contrast, in other countries the borrower is responsible with the rest of her assets. I once read a sad story of a Peruvian immigrant inn Spain. He bought a house near the peak of the boom which, in Spain, was much bigger than in the US. He could not pay the mortgage so he defaulted. The bank took over the house and sold it very cheaply. He ended up without a house but with a huge debt: he was responsible for the different between what he owed minus the (low) price the bank got. He was thinking of giving up and going back to Peru but, as I recall, he could not escape the debt because of an agreement between Peru and Spain. He lost everything he had and could not afford to go home.
The different treatment of loans is the reason that, while US households default often, European households do not.
In contrast, in other countries the borrower is responsible with the rest of her assets. I once read a sad story of a Peruvian immigrant inn Spain. He bought a house near the peak of the boom which, in Spain, was much bigger than in the US. He could not pay the mortgage so he defaulted. The bank took over the house and sold it very cheaply. He ended up without a house but with a huge debt: he was responsible for the different between what he owed minus the (low) price the bank got. He was thinking of giving up and going back to Peru but, as I recall, he could not escape the debt because of an agreement between Peru and Spain. He lost everything he had and could not afford to go home.
The different treatment of loans is the reason that, while US households default often, European households do not.
5. To QE3
The FED on Thursday announced two things:
1. QE3: they will be buying mortgage based securities to raise their price and reduce long term interest rates. Unlike the two previous round, there is no fixed amount of purchases set; the FED will do it for as long as it takes to get economy growing.
2. They also announced that they will not stop when the economy starts growing, but will continue for a "considerable time" to make sure that, when the monetary stimulus ends, the economy will continue to grow.
1. QE3: they will be buying mortgage based securities to raise their price and reduce long term interest rates. Unlike the two previous round, there is no fixed amount of purchases set; the FED will do it for as long as it takes to get economy growing.
2. They also announced that they will not stop when the economy starts growing, but will continue for a "considerable time" to make sure that, when the monetary stimulus ends, the economy will continue to grow.
3. The good judge did it before
when he rejected a $33 million settlement between SEC and the Bank of America. (in the end he approved a $150million
settlement).
A bit of background. On the crucial weekend
of Sep 13-14 2008, Bank of America agreed to acquire Merill Lynch, the third
largest investment bank in the world. The acquisition had to be approved by
shareholders. The Bank was sued since it did
not disclose, prior to the vote, that it agreed to bonus payments at
Merill Lynch of $5.8bln (in the end $3.6bln was paid). Another issue was that
the bank did not disclose expected Merill Lynch losses ($15bln) prior to the
vote (the details are here).
Judge Rakoff complained that any fines paid
by the bank hurt shareholders, who had nothing to do with the lack of disclosure.
Guess what: "Bank of America said it
was pleased with today’s decision.[...] Bank of America rose 40 cents to $16.28
as of 2:38 p.m. in composite trading on the New York Stock Exchange."
(source: see above).
Sum up: by Geto Boys Geto Boys; just replace "gangsta" with "banksta" (the term bankster was coined, as far as I know, by the Economist).
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