2013-66 The new normal?

Paul Krugman in the NYT comments on the sad state of the economy. Here is a summary

1. Even before the recession, when there was a bubble in housing and consumers incurred large debts, the economy was not in great shape

2. The recession ended four years ago yet the economy is still weak (this also applies to the Canadian economy)

3. So perhaps we are into a prolonged period of slow growth (he calls it a mild depression).

4. This means that only the monetary policy can help

Why is this happening? Krugman proposes two answers
- slowing population growth
- trade deficits (the second does not apply to Canada, although in recent years we have had fairly large trade deficits)

here are a couple of quotes:

"Again, the evidence suggests that we have become an economy whose normal state is one of mild depression, whose brief episodes of prosperity occur only thanks to bubbles and unsustainable borrowing."

"Why does all of this matter? One answer is that central bankers need to stop talking about “exit strategies.” Easy money should, and probably will, be with us for a very long time. This, in turn, means we can forget all those scare stories about government debt, which run along the lines of “It may not be a problem now, but just wait until interest rates rise.”"

2013-65 Malfeasance part 1576

Now it is currency trading

Before it was LIBOR and numerous problems of US and European banks related to the financial crisis.

Biggest problems - of the biggest bank in the US, JP Morgan

$4.5 billion for mortgage claims settlement
$13 billion tentative agreement
and  $23 billion for legal costs and future fines

By the way, the $23 billion for legal problems is more than total market capitalization of 2/3 of S&P 500

2013-64 Sorry kids

1. we ate it all (just kidding)
2. we did eat it all

You can watch the first but
DO READ THE SECOND
To encourage you, here is an excerpt:

"With graph after graph, they show how government spending, investments, entitlements and poverty alleviation have overwhelmingly benefited the elderly since the 1960s and how the situation will only get worse as our over-65 population soars 100 percent between now and 2050, while the working population that will have to support them — ages 18 to 64 — will grow by 17 percent. "

(the data are from the US, but the numbers in Canada are similar).

2013-63 Huge economic crisis

Huge economic crisis? What can it be?

Canadians do not save for retirement so politicians talk about the need to expand CPP. Right now it provides less than a $1000 a month. The proposals are to more or less to double it.

What is going on? Well, the boomer generation is retiring. So, to put it bluntly, it would like, as it has been doing in the past, extract money from the current young generation (you).

The increase in benefits will be funded by increased  contributions. But CPP is not a fully funded plan. In a fully funded plan, what you get is your contributions plus earnings made on your contributions by investing them. The alternative is a pay-as-you-go plan, whereby current contributions pay current benefits. CPP is a mixture of the two plans.

Bottom line: if CPP is enhanced as proposed, people who will retire within the next 40 years will not have paid in full for the increased benefits. There benefits will be paid, in part, by people who will not retire within the next 40 years.

That is you.

2013-62 An election strategy based on fiscal policy

Note: this is an opinion article.

In the opinion of the author, the federal government's reelection strategy is to:
- put the federal budget in surplus before the election
- cut taxes before the election, eliminating the surplus and leading to a balanced budget.
Why?
- people like tax cuts, so promising tax cuts is an election strategy;
- eliminating the surplus means that if the other parties promise higher spending or lower taxes before the election, they will face a deficit.

This an example of manipulating fiscal policy to the benefit of the party in power.

Now you know why the central bank should be independent.

2013-61. A useful opinion on ECB moves

The article is useful, because it shows how the ECB operated to solve the Euro zone crisis

The Euro area faced the same problems as the US during the financial crisis: the credit market did not function well, there was insufficient liquidity in the system and many banks had troubles meeting their obligations. The Long Term Refinancing Operation (LTRO) introduced by the European Central Bank (ECB) in 2011 aimed at solving the problem. Essentially it allowed banks to borrow near unlimited funds from the ECB at a low interest rate (1%) for a period of three years. Banks could use the funds however they wanted. So they borrowed large amounts and bought higher-yields assets, including government bonds. This helped another problem: high interest rates on debt of Italy and Spain, two weak countries of the Euro area. As banks bought Italian and Spanish bonds, their prices increased, and their interest rates fell. This led to an improvement of the fiscal position of the two countries as they could now borrow at lower rates.

How big was the program? Very big. For example in March 2012 the ECB lent over 500 billion Euro, or over $700 billion.

In August 2012 the ECB introduced another program, specifically aimed at reducing interest rates on long-term bonds of problem countries. Outright Monetary Transactions (OMT) is a program under which the ECB buys directly government bonds maturing in 1-3 years. The purchases are made in the secondary market. The purchases raise the prices of government debt and reduce interest rates on 1-3 year bonds. Through the term structure, they also reduce interest on long - term bonds. They also increase confidence of private investors, raising private purchases of government bonds and further increasing their price and lowering the interest rate.

The lesson from this: apart from setting the short-term nominal interest rate, central banks have many tools at their disposal to affect markets in time of  crisis.

But, as the article points out, the intervention creates moral hazard. By reducing fiscal difficulties of problem countries, it reduces commitment to fiscal reform. 

2013-60 Monetary policy in action

Somewhat unexpectedly, the European Central Bank lowered the short-term interest rate it controls to the lowest level ever (0.25%).

• Why was it unexpected? Of the 23 analysts polled before the decision, 22 thought there will be no change.
• What was the reason for the cut? The apparent reason is that inflation in the Euro - area is very low, at 0.7%. The ECB target for inflation is just below 2%.

As we discussed some time ago, a low rate of inflation, if it falls further, may become deflation. And everyone is afraid of deflation.
Note that, unlike the proposals we discussed in posting 2013-55 and 2013-57, the ECB is not at all aiming for a high rate of inflation. Rather, it wants to bring inflation closer to the target.

• Are there other reasons for the cut? perhaps. The Euro-area economy is weak (except for Germany and a few other countries) and the Euro has appreciated, making life difficult for exporters. Since, as we discussed in chapter 4, a lower interest rate leads to depreciation of the currency, making exports cheaper and imports more expensive.
• Another reason may be that the European economy is weak. Lower short-term interest rate, if it results in lower long-term interest rates, will provide stimulus to the economy. We will discuss the link between short-term and long-term interest rates today.

Indeed, markets think there will be an  improvement in the economy and they are up.

2013-59 Insider trading charges

SAC Capital, the hedge fund owned by S.A. Cohen, admitted to five criminal charges and agreed to pay a fine of $1.2 billion. They have already paid $600 million.

Reason - insider trading

The total fine, $1.8 billion, consists of illegal gains ($900 million) and penalty ($900 million).
As Mr. Cohen owns 100% of the firm, he will pay  the fine himself, leaving him with about $7 billion (he has recently bought a painting for $150 million and property for $60 million).

Why was the firm investigated in the first place? It had returns that were had to believe ( 30% per year).

When did the investigation start bearing fruit? When someone provided information into the workings of the company.

What is "too big to jail? " This is an issue that has been bothering economists and some politicians. Following the Great Recession, nobody went to jail. Typically, firms paid fines and admitted no wrongdoing. So the bankers were "too big to jail".

You will see commentary that the too big to jail is over. But for this really to happen, the government needs to charge the company owner, Mr. Cohen, one of the most powerful people in finance.

2013-58 Record unemployment in Europe

19.5 million people looking for a job and not finding it.
Unemployment rate  12.2%, over 25% in Spain and in Greece
Youth unemployment: over 55% in Spain and in Greece

2013-57 Now about the problems with inflation

If the inflation was raised, as Ken Rogoff suggests:

• the FED may lose control of inflation
• as inflation accelerates, any benefits will be swamped by "disruptive consequences of people spending money as soon as possible
• Inflation punishes people on fixed incomes
• It discourages lending and investment, slowing economic growth in the future

2013-56 Deflation in Europe

We have just talked about the possible (if doubtful) benefits of inflation. Here is an article about deflation in Europe
I am not sure you can read it - access may be restricted to subscribers - so here is a summary.
1. After underperforming for a long time, the Euro-area economy starts growing. But unemployment is high "And now, the single-currency club faces a more dangerous health risk stemming from fiscal consolidation, a surprisingly strong euro, excess capacity and tight credit conditions: economy-crippling deflation."

2. Inflation in the area is below 1%, the lowest level since 2008. Prices have been falling in France, Italy and Spain. Even in Germany it is only 1.6%.

3. So the ECB can safely stimulate the economy, without the danger of inflation.

4. If Europe falls into deflation, the cost of servicing debts will "rise dramatically". Italy in particular will be in trouble. According to one estimate, to keep the debt/GDP ratio constant, it needs to increase its surplus by more than 1% for each % decrease in inflation

5. What is at fault? Austerity

2013-55 OMG!

Inflation is the solution for economic troubles???????????????????????

This is a long and interesting article about the benefit of inflating our way out of the trouble.
The issue is important as the cornerstone of monetary policy in the last 20 years was a low and stable rate of inflation.
I would like to talk about it for a few lectures.
Here is the first fragment to discuss.

"Rising prices help companies increase profits;"
Correct or not?
"Rising wages help borrowers repay debts."
 Correct or not?
" Inflation also encourages people and businesses to borrow money and spend it more quickly. "

"The school board in Anchorage, Alaska, for example, is counting on inflation to keep a lid on teachers’ wages. Retailers including Costco and Walmart are hoping for higher inflation to increase profits. The federal government expects inflation to ease the burden of its debts."

Are they right?

Answers will come after we talk about it. It will be an excellent review of a few topics from the course.

2013-54 On currency investors

In today's Financial Post there is an article about currency investing. Basically, some people are worried that the US dollar will fall because of political problems  in the US. These people buy the Chinese yuan or baskets of currencies that are resource-linked: the Australian, Canadian and New Zealand dollar as well as the South African Rand.
The total amount of such investments is, however, relatively small.
The article mentions something we have been studying: investing in foreign currencies because of high return. One bank is offering 5.75% on the Brazilian real. But remember that for the investment to be profitable, the real cannot depreciate too much.

2013-53 On inflation and inflation statistics

Because of the weakness of the Canadian economy, inflation has been low


In an interesting article that you should read, the author discusses whether Statistics Canada inflation numbers can be believed.

I will summarize his main points:
1. People he knows complain that, in their opinion, inflation is higher than the 1-2% reported by Statistics Canada
2. Indeed, he says, several items increase in price at a higher rate: food, transportation, child care and, regrettably for you,  tuition fees (21% increase in the last 5 years);
3. Inflation is not the same for everyone. It is higher for necessities (food) than for more expensive items (electronics, cars). This exacerbates concerns about income inequality.
4. The best approach is to keep Statistics Canada independent; otherwise people will not believe its statistics.

Note point 3. The first part is trivial, of course. If you are a student with child care needs, you are facing big increases in the cost of living; if you are buy a lot of women's clothing and electronic equipment, you are enjoying deflation.
But the second part raises an important issue. Productivity growth is faster for manufactured goods than for foodstuffs. So, over time, poor families face rising relative prices.

2031-52 Baseball playoffs

Democrats win with a punt.
There is an agreement in the US to reopen the government until January 15, and extend the borrowing limit until February. In the meantime there will be discussions on how to fix long-term fiscal problems.

And the markets: they are doing their own thing

2013-51 Balanced budget

In the speech from the throne, the government promised balanced budget in normal times. In a recession, they would allow a deficit but with a detailed plan on when the deficit will be eliminated.
It is an interesting idea. Much better than proposals to have a balanced budget all the time.
But there are not enough details to evaluate it.

2013-50 Housing bubble in the UK

an interesting article on the UK repeating what happened in Canada in the Great Recession
Mark Carney, when he was the Governor of the Bank of Canada, was concerned about housing debt.
Now, as the Governor of the Bank of England he has the same concerns, in the UK.

2013-49 According to Warren Buffet

who is the idiot?

But he reports no changes yet in consumer demand.

2013-48 The Federal Government is concerned

that Absolute Purchasing Power Parity does not hold between Canada and the U.S.
Prices of many goods and services are, at current exchange rate, higher in Canada than in the U.S.

They blame it on tariffs and noncompetitive behaviour.

2013-47 More on Nobel winners and markets

Various publications have been stressing that there are differences of opinion between two of the laureates, Eugene Fama and Robert Shiller

Fama is of the opinion that markets are rational and a monkey, picking stocks by throwing darts at stock market listings, would do as well as a a professional money manager. Shiller thinks that  this is not true and that there are bubbles in the stock market (as well as in the housing market) caused by irrational behaviour of investors. In his view, share prices tend to the average price/earning ratio, and house prices to the long-run average proportion of income.

Shiller has a persuasive graph showing that prices return to long-run averages.


Here is an article from 2005 about Shiller's prediction that house prices in the US will fall

2013-46 The Yellen Fed? Precise and Predictable

The Yellen Fed? Precise and Predictable

The New York Times prediction on how Janet Yellen will run the US moetary policy is something you should read.
Here is what they stress:

"[...]in public speeches and academic work, she has suggested that the Fed should be more systematic, predictable and transparent — in short, that it should lay down some rules and stick to them. It is a template that Wall Street likes, and one that underscores the Fed’s departure from the days of Alan Greenspan, its chairman from 1987 to 2006, whose Delphic pronouncements were endlessly parsed by economists and investors." 

She is all for transparency and relatively simple rules.

Note the difference between decision-making at the White house and at the FED, stressed at the end of the article:

“The Fed meets every six weeks and makes usually one big decision after careful forethought and research,” the colleague said. “The White House meets every day and has 18 million things to deal with.” 

So a careful, deliberate approach is what is needed at the central bank.

In case you do not know what Delphic means, check out this download:

http://curiyo.com/

It installs as an add on to your browser and allows you to find things quickly.

Oops, it does not work on the blog, for some reason. But it works on many other sites

2013-45 Summers on the fiscal problem

Ok, so perhaps the US fiscal problem will be resolved on Tuesday, perhaps not.
It got boring by now. It looks like the best we can hope for is a temporary fix. So, for a fresh perspective, here is a comment by Larry Summers , former US Treasury secretary and former President of Harvard, who looks beyond the budget impasse.

The current fight is about the cuts to government spending as projections of future debt are dire. Summers makes a couple of interesting points:

• "Projections that there will be a major deficit problem are highly uncertain"

He points out that the same people who are very concerned about deficit and debt are not concerned about global warming, claiming insufficient evidence global warming is a problem. Well, there is much more evidence about global warming than about dire US fiscal future.

• "Data from the CBO (Congressional Budget Office, a non-partisan institution) imply that an increase of just .2 percent in annual growth would entirely eliminate the projected long-term budget gap."

So politicians should worry about growth, not deficits.

2013-44 And the Nobel Prize goes to

three academic researchers who studied the determination of stock prices.
Eugene Fama (Chicago) developed the theory of efficient markets. According to the theory, share prices are set on the basis of all available information that is rationally included by market participants. What this means is that, in the short run, prices are unpredictable, there are no unexplored market opportunities and it is not possible to regularly produce returns higher returns than the market. Hence index funds.
Lars Peter Hansen (Chicago) developed econometric techniques, originally used to test theories of market pricing but nowadays used in many different areas of economics.
Robert Shiller (Yale) showed that, over longer periods, there are predictable movements in share prices. He wrote a book "Irrational Exuberance" during the internet share price boom, arguing that shares are overpriced. And he was right.

2013-43 Our top man is confident, IMF less so

The minister of finance, Jim Flaherty, is confident the US will resolve the debt ceiling problem
This article lists important announcements in the next few weeks.
October 16: "Mr. Flaherty is expected to deliver his fiscal update — a recalibrating of economic growth and revenue projections — some time after the Speech from the Throne on Oct. 16."
October 23: Bank of Canada Monetary Policy Report. Here is the link to previous reports

The IMF published its bi-annual World Economic Outlook (WOE) 
Here is the summary

"Global growth is in low gear, and the drivers of activity are changing. These dynamics raise new policy challenges. Advanced economies are growing again but must continue financial sector repair, pursue fiscal consolidation, and spur job growth. Emerging market economies face the dual challenges of slowing growth and tighter global financial conditions."

Here is the summary for Canada

"The Canadian economy grew at an annual rate of 1¾ percent in the first half of 2013, driven by a rebound in the export and energy sectors, as well as private consumption. The economy is projected to expand at slightly more than 1½ percent in 2013 and 2¼ percent in 2014, as net exports and business investment benefit from the U.S. recovery and more than offset slower consumption growth. The balance of risks to Canada’s outlook is still tilted to the downside, emanating from potentially weaker external demand. Moreover, household debt remains historically high, which could amplify the negative growth impact of adverse shocks to the economy. Policies need to continue to support near-term growth while reducing domestic vulnerabilities. Fiscal consolidation, particularly at the provincial level, must proceed as planned to rebuild fiscal space against future shocks. The current accommodative monetary policy stance remains appropriate, with gradual tightening expected to begin in the second half of 2014."

 

2013-42 Janet Yellen to lead the FED

Janet Yellen is to be nominated as the new FED chief
She is currently the deputy chair of the FED, was the presedent of the San Francisco Fed and a professor at Berkley. Her biggest contribution in economics is the efficiency wage theory, which she developed with her husband, Nobel Prize winner George Akerlof.
The Wall Street Journal analyzed economic forecasts  by FED policymakers over 2009-2012. She came first
If confirmed (very likely) she will be the most powerful woman in economics and finance.

Here is the best summary of how she may be different from her predecessor: comment made by Derek Holt, Dov Zigler, Bank of Nova Scotia (from the Globe and Mail)

“Yellen has been a fairly consistent advocate that the Fed cannot ignore the ‘full employment’ component of its dual mandate. Over the past number of years, Yellen has tended to speak directly and bluntly about the FOMC’s responsibility to pursue an accommodative monetary policy in order to try and encourage full employment in the economy."

2013-41 Our trade deficit

For a year and a half, Canada had a trade deficit
Why? Relatively strong economy. A part of all spending is on imports; if spending increases, so do imports.
Also, the Canadian dollar is overvalued, making Canadian goods expensive relative to foreign goods.
We have a big surplus with the United States ($4 billion) and a big deficit with the rest of the world ($5.3 billion). Note that three quarters of our exports go to the U.S.

2013-40 IMF says the U.S is a problem

IMF head warns US debt crisis threatens world economy
There is a graphic in the article showing US debt and increases in the debt limit.
Ms. Lagarde says it is critical that US
1. fixes its current problem
2. does not cut too much in order not to derail the recovery.
Also, she says the world economy is doing find

2013-39 The sky is falling! But do not look up

No agreement so far on the budget; and the House Speaker threatens default (see any paper today).
The markets fell, but not a lot: between 0.25% and 1%.
Market volatility increased, but is still not very high.
So we will see what happens.

2013-38 How we define exchange rates

The exchange rate is the price of one currency in terms of a foreign currency.
As in:

• the exchange rate of the Kuwaiti dollar in terms of the Vietnamese dong (KWDVND=X) is almost 75000 of dongs for one dollar.
• the exchange rate of the Chilean peso in terms of the Canadian dollar (CLPCAD=X) is about 2/10th of a cent for one peso
• the exchange rate of the Canadian dollar in terms of the Chilean peso (CADCLP=X) - well, check it yourself or see the previous posting.

2013-37 How to check exchange rates

We will be talking about the exchange rates today. Here is how to check them.
1. Find out the symbols for currencies from the Oanda website
2. go to yahoo finance and enter the two currencies as in, for example:
CADUSD
This gives you the price of one Canadian dollar in US dollars, or the exchange rate of the Canadian dollar in terms of the US dollar.
More examples: 
The exchange rate in terms of  the Euro
The exchange rate in terms of the Chilean peso
The exchange rate in terms of the Vietnamese dong
The exchange rate in terms of the Kuwaiti dinar


3. If you want historical information, Oanda.com is a great resource

2013-36 CIBC's mortgages are insured

The CIBC has a fast growing mortgage business. After the Great Recession and its aftermath, this raises concerns about what can happen if the economy gets worse and borrower default rises.

No worries, says the CIBC. Our mortgages are insured. If borrowers default, we get the insurance payments.

This comment shows that Canadian banks learned a lesson from the Great Recession in the U.S.

A couple of comments:
1. So who will pay the insurance? You, that is who. Mortgages are insured with the Canada Mortgage and Housing Corporation (CMHC), a government entity. Banks pay for insurance so it should be ok, unless things get very bad.
Note, however, that CHMC is earning a profit. So we get a profit, and a tail risk.
2. The problem during the Great Recession was adverse selection and lower lending standards. This is a bank-centered article and it does not say a word about whether CIBC is maintaining high lending standards.

2013-35 But things are looking better

While unemployment in Spain is still unbelievably high as you saw in the previous post, things are getting better in Europe

This article is a good example of how you take a pulse of the economy.

1. Retail sales have been increasing (0.7% this month, 0.5% last month)
Consumption is, in most countries, more than 50% of the GDP. When consumers are buying, the economy is growing.

But you have to be careful because, as the article mentions, an unknown part of the increase in consumption was because sales in Portugal and Spain increased a lot, perhaps due to tourism sector rebounding.

Note: the numbers just published are for August. Information comes with a delay. In this case the delay is very short - just a month.

2. Survey of economic activity.
Purchasing manager index - a survey of firms - is above 50. This means that more than half of the managers reported that conditions are better than in the previous month. Purchasing managers are asked about output, new orders, employment and other issues. The answers are coded as: 1 - things are improving; 0.5 - no change, 0 - things are getting worse. The calculated value is a weighted index of answers.
Three things to note:
- purchasing managers are the first to know
- they are asked non-specific questions, so the are likely to answer. No trade secrets are revealed
- the questions are about fact, not opinions

3. Number of unemployed has been falling, third month in a row

2013-34 So how bad is it in Spain

Quite bad.
Unemployment is 26.3%, down from a record of 27.2%.
And youth unemployment (your age) is about twice higher.

2013-33 Shutdown and Canada

Here is a summary form the Globe and Mail and from the National Post

The exact rules of the shutdown are not set in stone. So it is not clear whether there will be any delays on the border.

The markets have already incorporated the shutdown into share prices, so do not expect much reaction. But, as another example of political issues in the US, in the medium run share prices are likely to be lower than they would have been otherwise.

There will likely be little effect on the economy. If the shutdown drags on for more than a couple of weeks, growth in the US will slow; with minor negative effects on our economy.

The big one will come around October 17, when the debt limit will become binding and the US government will not be legally allowed to borrow new money. Perhaps the politicians will come to an agreement by then.

2013-32 Shutdown indeed.

As there was no last moment agreement on funding the U.S. Federal Government, the shutdown started.

What happened?

• The budget has not been approved on time 

How it unfolded? 

• The New York Times provides a useful graphic 

How will it work (or rather - not work)?

• The US government will continue to operate; but only with essential workers
• Non-essential workers will be furloughed. What is a furlough? It is a temporary unpaid leave leave caused by demands of the employer. Most other workers may be unpaid, for the duration of the shutdown, but will be paid afterwards.
• Military personnel will be paid.

The New York Times provides another useful graphics 

Mechanism:

US has an unusual system of government in that the legislative and executive branches are separately elected. In Canada, certain legislation (including on the budget, as is now the case in the US) are automatically votes of confidence in the government. If such a vote fails, the government resigns and a new election is held. Parliamentary majority is usually sufficient, because of party discipline; under a minority government, the governing party needs support from other party or parties to pass legislation.

How is US budget resolution approved?

The House and the Senate need to agree on the resolution, and the president needs to sign it. If the president vetoes the resolution, the House and Senate can override it with a 2/3 of the vote.

In this case, the House and the Senate did not agree.

Why the shutdown?

The Republicans, who have majority in the House of Representatives, tried to impose conditions on the budget resolution. The Senate rejected the conditions.

While one of the conditions involved approval of the Keystone XL pipeline from Alberta to the Gulf-area refineries, the main issue is the Affordable Care Act, or Obamacare. The Republicans are dead set against it; the House held around 43 votes rejecting it.

More details are here

So who is right?

This is politics, but with economic consequences. Here is a comment from robertreich.org:

"[...] the only settled way we know what the American people want is through the democratic process. And the Affordable Care Act (Obamacare) is the law of the land. A majority of the House and Senate voted for it, the President signed it into law, its constitutionality has been upheld by the Supreme Court, and a majority  of Americans reelected the President after an election battle in which the Affordable Care Act was a central issue."

So this is about the Republican party achieving goals by means beyond the normal constitutional system.

2013-31 How markets react to news

The news of the pending shutdown resulted in small declines in markets

Why small? Because it was expected
Why a decline at all? Because the matter is closer to a negative resolution than it was on Friday. So it is still news.
What may happen if there is no shutdown? Hard to say.

2013-30 Shutdown!

It looks like the US will not come up with a budget by midnight. As a result the so-called shutdown will start. It is for the 17th time in 37 years. Out of recent presidents, only George W. Bush did not experience a government shutdown.
What you shoud know: the Globe article mentions a few things.

• What it is about? The Republican party wants to derail the Affordable Health Act, or Obamacare. They need to agree on a budget but they put forward conditions that the Democratic party rejects
• What will happen? Non-essential government personnel will not work or be paid. The rules change but if you are planning to visit Yosemite, forget it (National parks do close). There can be lineups on the border.
• Debt default is not now, only on October 17, if they do not come to an agreement. That would be a disaster.

My comment: Loonie is not just a one dollar coin

2013-29 Economic discrimination against women

A report was just published  by  the World Bank. They looked at laws that make a distinction between men and women: "in almost 90 percent of the 143 countries surveyed in the World Bank study, at least one law remains on the books to bar women from certain jobs, opening a bank account, accessing capital or making independent decisions."

So despite progress, women have equal rights only in a minority of countries. The biggest offenders are in the Middle East and in Africa. Some of these countries have oil; others are poor. No wonder.

2013-28 $11 billion

is the today's estimate of the fine on JP Morgan related to mortgage-based securities.
The bank is in negotiations with regulatory agencies in the U.S.; $11 billion is the rumored amount. Yesterday the talk was about $3 billion - see post 2013-23

So what happens with shares of a bank that may be paying a record - breaking penalty? They go up.

There are two interpretations:
1. Wall Street Journal's (the view from Wall Street)
the fine puts the legal problems behind, and the bank will be able to concentrate on what it does best (i.e. money)
2. My suggestion: there was talk of $20 billion. So if they end up with $11 billion, it is not so bad.

Here is the Wall Street Journal article, in case you cannot read it online

Knowledge Is Power at J.P. Morgan

Investors May Be Seeing Some Light at the End of the Firm's Legal Tunnel

By
• DAVID REILLY

Eleven-figure legal settlements are scary for any company, even big banks. But for investors, there is also something to be said for certainty.
J.P. Morgan Chase JPM +2.74% appears to be nearing a settlement with federal and state regulators over mortgage-backed bonds. The possible price could be a cool $11 billion or even more.
Only a portion, possibly $7 billion, would be cash, with the remainder coming through relief to consumers. Even so, that is still a big hit, equal to nearly a third of the bank's forecast 2013 net income. Yet J.P. Morgan's stock rose nearly 3% Wednesday.
One possible reason: A deal would show the bank is getting some of its numerous legal issues sorted. A week ago, it settled for nearly $1 billion charges related to its "London whale" trading debacle. And even a big number at least allows investors to quantify the damage.
Consider Bank of America. In recent years, it entered into settlements worth many billions of dollars related to mortgage securities, including an $8.5 billion agreement still subject to legal challenge. Yet BofA's stock rebounded as it showed it was whittling down its mountain of legal woe and could handle the cost.
Granted, J.P. Morgan's settlement, if reached, could cause larger-than-expected legal expenses for the current quarter. While the bank had signaled those would likely be more than $1.5 billion, the charge could now end up even higher. And the bank still faces other regulatory and legal issues.
For investors, though, just being able to put a figure on such hits is half the battle.

2013-27 Banks still need more capital

According to an estimate, banks have insufficient capital.
The good news: the shortfall fell by almost a half in the first half ot 2013; the bad news is that European banks are behind.

2013-26 Robin Hood in reverse

Here is an article from the Forbes that addresses one of the biggest economic problems: the growing inequality. Income inequality has been growing in most developed countries in recent years. It gave rise to the Occupy movement in many countries. We do know that the bigger income inequality, the less happy people say they are. The effects of income inequality on economic performance are debatable.
Income redistribution is not really an economic question: it is a social question and different societies approach it differently. In Scandinavian countries income taxes are very progressive, income inequality is low, people are happy and quite wealthy. There are other societal arrangements as well.

Here is a voice from the other side. Mr. Binswanger argues that the rich should pay no taxes and that the 99% should give to the 1%.

Well, he is obviously .... , let us say politely Hobin Rood, or Robin Hood in reverse

But why is this argument wrong from the economic point of view?

2013-25 US to run out of money

US will run out of money by October 17
So by then the borrowing limit needs to be raised (see posting 2013-22)

2013-24 Insider trading 2.0

What is insider trading? It is trading on information that is not publicly available.
Does it matter how the information was obtained? Probably not very much for the trader, but I am not a lawyer.
But it matters for the provider of the information. How about someone selling the information for a profit?
Well, it turns out that things are more complicated that one may think. Here is the story
and here is the explanation from a law professor
The story: University of Michigan conducts a survey of consumer sentiment. The results of the survey provide important information to market participants and move share prices.
The UofMichigan provides the study to Thompson Reuters, which sells it to a select group a couple of seconds before making the information public.
The institutions that get an early peak at the data are the so-called high-frequency traders. They have powerful computers, and sophisticated computer programs, which allow them to make trades within milliseconds of receiving information. So the 2 seconds advance information is sufficient for them to make trades before the general market learns the results of the survey.

In a nutshell, the law professor says that an institution that holds information obtained through research can do with it as it pleases. It may be unfair to sell early access to information, but it is not illegal. Companies must release information about themselves simultaneously to everyone. But the survey information is not about Thompson Reuters.

Below is some legal info from Professor Henning:

"Although it is natural to think that having access to information that influences the markets before others is always wrong, the laws on fraud do not go that far. Instead, they focus on whether someone has been deceived, either through a misstatement or by a failure to disclose information [...] the core of any violation is still about proving fraud, which includes not just false statements but also any “deception, concealment, suppression, false pretense or fictitious or pretended purchase or sale” of securities.[...]
Thomson Reuters and others who selectively disclose information to subscribers are not hiding what they do. Indeed, it is the exact opposite — they tell the world that only those willing to pay will get the advantage of an early peek at the information."

And so it is all legal but unfair.

2013-23 Malfeasance continued

I wanted to take a break from the chronicles of malfeasance, but news took over. The biggest bank in the US is JP Morgan. It did pretty well during the Great Recession. But now it is facing numerous investigations. So - a banker's idea  - why don't we just pay off the investigators
This is from the WSJ, Just in case you cannot see it, a summary: they propose to pay a fine of $3billion.
Sounds like  a lot of money. But maybe it is not. It is less than half of their last quarter's profits.
Below is the list of fines so far.

I have seen a report  that a government agency proposed a fine of $20 billion. It will be interesting to see how it ends.
Andrew Ross Sorkin makes an interesting point about fines for malfeasance. Who pays them? Shareholders. Who is guilty? Management. Talk about other people's money.
In the "London whale" fiasco, the company lost $6 billion. This reduced profits and the value of shares. Now they paid almost $1 billion in fines. This reduces profits and the value of shares, yet again.

2013-22 Problems in the US

In a week the U.S. government may partially shut down. It current spending authority runs out at the end of the month. The House of Representatives and the Senate must agree on a continuing spending resolution to fund the government. It then has to be signed by the President.
So far the House, which moves first, approved a continuing spending resolution that provides the authority to spend money but defunds the health - care plan popularly known as Obamacare. The Senate will not agree to this; it will remove the defunding provision and send it back to the House. What happens afterwards is anyone's guess.
The government shutdown is not a terrible problem; it happened before (in 1995/96).
It is possible that it will be avoided as the action is very unpopular: in a recent poll 59% of Americans were against linking the funding bill to Obamacare, 19% is for.

But there is another looming problem. The U.S. cannot legally borrow more money because of a legislative limit on debt. In the middle of October it will run out of money and will not be able to fund its operations. One possibility is that it will default on debt. If this happens, the damage to the world economy will be enormous.

I will keep you informed.

2013-21 The policy dilemma in India

India is facing a policy dilemma. Inflation is high, and the economy is weak. What to do?
The new governor of the India's central bank, Raghuram Rajan is a leading macroeconomist from the University of Chicago business school. His answer: inflation is a bigger problem. So the central bank is raising interest rates.
Inflation in India is 9.5%, extremely high by current standards. The Reserve Bank of India decided that inflation is now a more pressing issue than output and, if it is not adressed now, it will become a bigger problem in the future. We have seen this in Canada in the early and in the late 1980s, when two recessions were caused by anti-inflationary policies of the Bank of Canada.

Question: The new interest rate is 7.5%, the inflation rate is 9.5% so the Reuters journalist concludes  "the cost of living is rising faster than interest rates." Is the journalist right?

2013-20 Greece on the mend

According to the latest reports, Greece may achieve a primary surplus in 2013. This is a condition for asking for more help. So if they do manage to have a primary surplus, it will be a sign that Greece is on the mend.
What is primary surplus? It is a difference between current revenue and current expenditure, and does not count interest payments on debt.
I have always thought that it is a strange measure, with only one sensibel application. A country that has a primary surplus can default on its debt and, if nobody does anything, wil have sufficient funds to survive. But of course creditors will do something, for example take over export receipts. So you tell me what the significance of a primary surplus may be.

2013-19 Chronicles of financial misconduct - Canada edition

Last week the Ontario Securities Commission reached a settlement with Ian Telfer, Chairman of Goldcorp Inc (current market cap $21 billion). The details of the agreement are here.
Two things worth noting:

• Advising Agueci to use Blackberry PIN messages instead of email 

• Non-disclosure of the beneficial ownership of shares

Details are further below.
As part of the agreement "Telfer agreed to pay $200,000 toward the investigation costs.

He also cannot “directly or indirectly, trade, arrange for trading by others,” any securities of issuers of which he is a promoter for one year." (this is a quote from a Toronto Star article).

Below is a part of the Settlement Agreement (Click here for the entire agreement). Look in particular on the details of a couple of transactions in points 21, 23 and 27a.

I first read the description of the settlement in  he Globe and Mail (their report is here). It does not provide the details mentioned above. I then read the description in the National Post, and researched the matter further.

Advising Agueci to use Blackberry PIN messages instead of email
15. In and about January 2008, Telfer advised Agueci to use Blackberry PIN messages instead of email.
16. On January 29, 2008, Telfer advised Agueci in an email as follows:
Go to the “wrench” on the homescreen and click on “status” Send me the #. On my address beside the pin: [pin number] Instead of emailing. Use pin with very close friends. Messages don’t go to the gmp server. They go straight to blkberry.
17. The use of Blackberry PIN messages is a technique which Telfer now understands that Agueci subsequently used to communicate with others in relation to trading securities.
18. Agueci on occasion asked Telfer via Blackberry PIN messages about companies in which she was invested. Agueci and Telfer also discussed via Blackberry PIN messages Agueci’s investment in a company for which he was Chairman.
19. Telfer acknowledges that irrespective of his reasoning for using Blackberry PIN messaging from time to time, it was not proper of him to advise someone working for a registrant such as Agueci to use Blackberry PIN messages where those messages would not be monitored. At the time, Telfer had no knowledge of how Agueci used her Blackberry to communicate with others and he had no knowledge of Agueci’s other conduct as alleged in the Statement of Allegations.
20. From time to time Telfer and Agueci exchanged updated PIN numbers.
Non-disclosure of the beneficial ownership of shares
21. In April 2008, Telfer provided Agueci with the opportunity to purchase 500,000 common shares in a private share transaction in 222 Pizza Express Corp. (“222 Pizza”). 222 Pizza was a shell company listed on the NEX board of the TSX Venture Exchange.
22. Telfer advised Agueci that the 222 Pizza shares should not be purchased in her name. During the discussion Telfer and Agueci agreed that Agueci’s brother in law, Santo Iacono (“Iacono”), would instead purchase the 222 Pizza shares.
23. As agreed, Iacono purchased the 222 Pizza shares in his name for $5,000. Telfer now understands that Iacono deposited the 222 Pizza shares in a brokerage account held jointly by him and his wife.
24. At the time of the transfer, Telfer knew that Agueci had disclosure obligations and trading restrictions as an employee of GMP. Telfer knew that Agueci was prohibited from engaging in undisclosed securities transactions.
25. Prior to the transfer of 222 Pizza shares to Iacono’s account, Telfer corresponded directly with Iacono and other investors, and advised them of particulars of the transfer and emphasized that they should “keep this confidential”.
26. Subsequent to the transfer of 222 Pizza shares to Iacono’s account, 222 Pizza went through a corporate reorganization, investment in gold stream royalty agreements, and the renaming of 222 Pizza to Kadywood Capital Corp. and then Gold Wheaton.
27. Telfer now understands that:
a. the 222 Pizza shares were sold in Iacono’s account and ultimately yielded a return of over $500,000;
b. Agueci used those proceeds to, among other things, direct trading in Iacono’s account in securities of other issuers that were then listed on GMP’s grey or restricted list;
c. in or about the same time as the purchase of 222 Pizza shares, Agueci purchased and sold shares of Kadywood/Gold Wheaton in her brokerage accounts at GMP and TD Waterhouse which were monitored by GMP compliance. The sale of these shares in Agueci’s GMP and TD Waterhouse accounts yielded a return of over $71,000; and
d. Iacono subsequently transferred funds from his account to Agueci or on her behalf, at her request, frequently in allotments of under $10,000, which had the effect of avoiding regulatory detection. Telfer further understands that approximately $200,000 was paid to/for Agueci in this manner.
28. Telfer acknowledges that if Agueci’s interest in or trading authority over the 222 Pizza shares in Iacono’s account had been disclosed to GMP, that GMP’s compliance department would have been able to monitor trading in that undisclosed account, just as they monitored trading in Kadywood/Gold Wheaton shares in Agueci’s GMP and TD Waterhouse accounts, to ensure that Agueci was not conducting trades inappropriately.
29. Telfer’s agreement with Agueci, a person with securities transaction reporting obligations, to have another name associated with the private share transaction of 222 Pizza shares, resulted in a transaction in which the beneficial owner of the shares was not disclosed. Telfer ought to have known there was a real risk that Agueci might have a beneficial interest in those shares that was not monitored by GMP, as required.

2013-18. Bank of Canada sees good times

The governor of the Bank of Canada spoke shortly before Fed's announcement. He sees good things ahead for the Canadian economy.

He points out that, with the economy improving, business confidence increases and he expects that firms are going to increase investment soon.

Note the last sentence. The interest rates have been kept low since 2010 and analysts do not expect an increase until the next year. We will see if the Bank of Canada surprises, or does not surprise, analysts.

2013-17 FED talks, world reacts

No end to monetary stimulus means loose U.S. monetary policy. This spills over around the world and stock markets rise

2013-16 FED decided to keep the monetary stimulus

to the surprise of analysts

It seems the problem is communication. The FED appeared to be ready , and signalling, a reduction in bond purchases.

There are two lessons:
- transparency
- things may change over time

Transparency: The analysts do not say that they expected the stimulus to weaken because of the state of the economy; they say that it was because of FED's words.

In recent years central banks have been switching towards clearer communication. In the past they avoided being clear about their goal and policy, being concerned that if they do not deliver as promised, they will lose reputation. The thinking has changed and now Banks try to be transparent and open about what they think about the economy. Bank of Canada was one of the pioneers, providing markets with detailed information about the economy and its thinking. This time transparency did not work with the FED.

 Changing economic conditions.  The decisions of the FED are collective decision, by voting of  its Open Markets Committee. The committee updates its information continuously and, apparently, its members felt the economy was not as strong as they thought.

2013-15 The chronicles of financial misconduct

1. Es tu, Teachers?!

2. The London whale

3. And one more (actually, this is the first one).

Say you missed the title and what it is about. How can you figure out that it is a matter of high finance? Easy: "Twenty-two of the firms have agreed to settle the civil charges, though they did not admit or deny wrongdoing."

But do not get depressed, there is good news too, in case you are sleepy in the US.

2013-14 FED policy and emerging markets

Here is an article about the worries in emerging markets about the end of the monetary stimulus

2013-13 Less of the monetary stimulus

The FED has been meeting in Washington and is expected to change the current policy of purchasing $85 billion of assets every month
The FED has been buying long-term securities in huge amounts as a part of three-element strategy to stimulate the economy:
1. A traditional approach: lower the short-term interest rates;
2. Forward guidance: promise to keep short-term interest rates low for an extended period of time (until unemployment falls to 6.5%);
3. Quantitative easing: purchases of long term securities

2 and 3 are unconventional and were introduced following the Great Recession. The reason: zero bound on interest rates. The currents level of interest rates can be found here.
The important rate is the first one: the Federal Funds Rate; this Wikipedia article explains what it is.
Since short-term interest rates cannot be reduced further, hence the need for extra measures.

The goal of these measures is to increase liquidity in the economy, promoting lending and investment. This also creates a potential problem since more liquidity leads, in normal times, to inflation. As long as the economy is depressed inflation does not increase. The task of the FED is to reduce the stimulus in such a way that
- the economy does not suffer too much
- inflation does not rise too much

The whole thing is unprecedented. Monetary policy is a mixture of science (whereby the decision-makers use available evidence and the knowledge of their staff and their own) and art (usually described as - well - decision-making based on accumulated wisdom and experience). This time the mixture involves more art than usual.

2013-12 The economy is improving

says RBC

2013-11 A complex unemployment picture

Paul Krugman argues that unemployment situation is worse than it appears

2013-10 More on the fianancial crisis

on the occasion of the fifth anniversary:

The untold story of how Canada survived the financial crisis from the Globe and Mail. This is very long but really good.

Andrew Ross Sorkin (check him out on Wikipedia) speculates on What might have been.

Here is a good point: "It is also worth noting that most of Wall Street was convinced that the failure of Lehman Brothers would not pose a systemic risk. In truth, in the fairy-tale version of bailing out Lehman, the next domino, AIG, would have fallen even harder. If the politics of bailing out Lehman were bad, the politics of bailing out AIG would have been worse. And the systemic risk that a failure of AIG posed was orders of magnitude greater than Lehman's collapse."

 

Lehman Brothers collapse  five years on, we're still feeling the shockwaves - mostly British perspective from the Guardian.

2013-09 Mortgage-based securities.

Here is a detailed story of one such security that did not work out as planned.

And a bit more on subprime lending

One of the most egregious cases was Countrywide Financial. Its boss was Angelo Mozilo. A son of a butcher - well, read the rest in his bio on Wikipedia
He made almost 500 million dollars running the company. He was then prosecuted, settled for $67.5 million (of which he paid only $20 million) and was banned for life from serving as an officer of a public company. He admitted no wrongoing.

Now he is, apparently, a "Fallen Titan"  and good guy.

I think the original titans would have objected. 

2013-08 Five years after the Great Recession Started

Various publications reflect on the five years since Lehman Brothers collapsed. You can find a wide variety of opinions. Here is the one I find the most interesting.

Matthew Yglesias summarizes well what we have, and have not, learned from the crisis.

1. Ending the financial panic of 2008-2009 was not sufficient to get the economy on track
2. Economic predictions were too optimistic. They mention a projection, made in 2009, that the unemployment rate in the US will peak at 8% and will be 5.5% by now. Actually, the unemployment rate reached 10.6% in the US (and 8.8% in Canada, which was less affected) and is still over 7%.

Bottom line: a financial crisis drags on for a long time. This is the message of a well know book by Reinart and Rogoff: "This time is Different" (warning: it is a long read).

3. In 2002 Bernanke, then not yet the chair of the US central bank, pointed out that we will not repeat mistakes from the Great Depression. During the Great Depression the FED reduced the money supply, leading to a prolonged slump. This time monetary policy was expansionary, with interest rates near zero and new measures: forward guidance (promises to keep interest rates low for a long time) and quantitative easing (massive purchases of long-term securities).

4. We still do not have a good answer on what policy can help the economy create jobs. See posting 2013-11.

2013-07 The Economist on the financial crisis

Here is an excellent summary of the financial crisis from the Economist

2013-06 Income of Canadians

Yesterday, Statistics Canada released a publication Income of Canadians. It provides lots of information on where Canadians get income from, how income is distributed across the population and how income is redistributed through public institutions, among others. Some highlights:

• ·        Over 95% of Canadians aged 15 and over received income in 2010,
  83% - some income from private sources.
  
  
  Ø  70% - some income from government transfers
  Ø  13% - only from government transfers
  Ø  predominantly from private sources, and
  
  
  ·         Median total income of almost $30 000
  
  
  Ø  7/8^th of total from private sources
  Ø  1/8^th  of total from government
  
  
  ·         Employment was the main source of income for Canadians
  
  
  Ø  70% of Canadians aged 15years and over earned income through employment.
  Ø  Employment earnings – ¾ of  the total income received by private households
  
  
  ·         Income redistribution through income taxes and government transfers
  
  
  Ø  Government transfers made up a large proportion of the income of seniors and of Canadians with the lowest income
  -          41. 1 % of the total aged 65 years and over;
  -          90% of these transfers came from Canada Pension Plan/Quebec Pension Plan (CPP/QPP), Old Age Security pension (OAS), and Guaranteed Income Supplement (GIS).
  
  
  Ø  For the 10% of Canadians with the lowest family after - tax incomes, government transfers contributed 2/3 of their income.
  Ø  Collectively , Canadians in each of the lowest five deciles received more money from government transfers than they paid in income taxes
  Ø  The 10% of Canadians with the highest family after - tax incomes paid 25 % of their income in income taxes and received 2% of their income from government transfers

It seems that papers concentrated on what one needs to earn to be in the top 1% ($191 000). You may read about it in the National Post but keep in mind (it is fairly obvious) that Terence Corcoran is extremely biased.
By the way, he does suggest that the publication is misleading. No, it is not. It is a survey of 4.5 million of households, and is done by statisticians whose only agenda is to provide good statistical information. Statistics Canada is one of the best statistical offices in the world. You can use their data with full confidence.

2013-05 Dangers of ending the monetary stimulus by the FED

Here is the one of the most important issues in monetary policy that we will be following this term.

Some background: with the economy weak, the US central bank (FED) introduced several rounds of monetary stimulus. The one in question involves monthly, large scale  purchases of long-term bonds, often called QE3 (for the third round of Quantitative Easing). The aim: to increase the price of bonds and reduce long-term interest rates (as we will learn later in the course, there is an inverse relationship between bond prices and interest rates).

These purchases eventually have to stop as they increase liquidity in the economy and will cause inflation. The FED has been talking about the end of QE3 for the last few months.

The article points out the dangers of ending the stimulus. It compares the current situation to that in 1994. Then, as the FED tightened policy, the bond markets crashed around the world. Now the stimulus is much larger than in 1994, and international links are stronger. So the end of the stimulus may lead to a global bond crash.

Solutions proposed by the policymaker mentioned in the article (Joerg Asmussen, a member of the ECB - European Central Bank - board) is clear communication, so that markets are not surprised, and monitoring inflationary expectations.