2014-54 for the Money and Banking class

This just in: a report on how to reform Canada's payment system, with details on how it operates

2014-53 Japan slips into a recession - and the dates of Canadian recessions.

According to the recent economic data, GDP in Japan fell last quarter. This was the second consecutive quarter of output decline and so newspapers announced Japan is in a recession.

How is recession determined? The common definition is two consecutive quarters of falling output. But this is not a definition used by economists.

Governments typically do not formally announce when the economy is in recession, in part because such announcement may not be credible. For example the government in power may be tempted to declare, before an election, that the economy is booming. Instead, the dating of recessions is left to independent economists. In Canada, the C.D. Howe Institute, an independent research organization, has recently undertakenthe task of systematically dating Canadian recessions. The C.D. Howe Business Cycle Council determined, for example, that there was an expansion from April 1992 to October 2008 (the longest since the beginning of the data, in 1926), and a recession from October 2008 to May 2009 (one of the shortest). In the United States, most economists accept the dates for business cycle recessions and expansions determined by the National Bureau of Economic Research (NBER). For example, NBER determined that the business-cycle expansion began in November 2001 and ended in December 2007, and it determined that the following recession ended in June 2009, when the next expansion began.

How does the C.D. Howe Institute’s Business Cycle Council determine when a recession begins and ends? There are no simple, clear rules. The Council defines a recession as a pronounced, pervasive, and persistent decline in aggregate economic activity. The Council looks both at the length and size of the decline in output and employment and the sectors of the economy that are affected. To call a recession, the Council requires that output falls for at least one quarter. The decline in output needs not be large, but it has to be persistent: A 0.1% drop in GDP in one quarter when in adjacent quarters the economy is growing strongly would not be considered a recession. The Council also looks at the proportion of sectors with falling output, particularly in manufacturing and construction. These two sectors vary the most over the business cycle. A general decline accompanied by robust growth in manufacturing and construction is unlikely to be a recession.

The recession timing as determined by the C.D. Howe’s Business Cycle Council is as follows:

C.D. Howe Recession dates
Beginning, quarter	End, quarter
1929:Q2	1933:Q1
1937:Q3	1938:Q2
1947:Q2	1948:Q1
1951:Q1	1951:Q4
1953:Q2	1954:Q2
1960:Q1	1961:Q1
1974:Q4	1975:Q1
1979:Q4	1980:Q2
1981:Q2	1982:Q4
1990:Q1	1992:Q2
2008:Q3	2009:Q2

The Great Recession, as you can see from the table, was short - it lasted only 3 quarters, the 1990-1992 recession lasted almost 4 times longer. The term Great Recession is imported. It was the worst recession in the U.S. since the Greta Depression, but in Canada it was not as bad.

The economic data used by the C.D. Howe are collected by Statistics Canada, the Canadian federal statistical agency. Statistics Canada is generally considered to be one of the the best statistical offices in the world. It provides estimates of macroeconomic variables fairly quickly and the estimates are quite accurate: subsequent revisions are small. Nonetheless, the information is retrospective: first, the data measure economic activity during a period that has already passed; second, the collection and processing of data takes time. As a result, the start of the recession is determined several months after the recession has begun. The C.D. Howe Business Cycle Council list of recessions was published more than two years after the end of the last recession, and we do not know how long its delay in announcing future recessions and expansions will be. In the United States the delays are also substantial. For example, the announcement that the most recent recession began in December 2007 was made by NBER twelve months later, in December 2008.

2014-52 New rules on bankers' pay

In the UK, new rules are being debated for bankers' pay. Essentially, bonuses will be deferred for a long period of time (7 years) and not paid if wrongdoing is uncovered. There is pressure to apply those rules to traders and brokers.

The underlying idea: crime should not pay.

2014-51 Insider trading in Brazil

As this article points out, while in the U.S. (and, sometimes, in Canada) insider trading leads to criminal prosecution and jail, in Brazil nobody has ever gone to jail for insider trading

The person in question, Eike Batista, was once predicted to become the richest person in the world. He was worth $35 billion; now he is accused of insider trading.

2014-50 This pesky arithmetics

Question: At the beginning of the year the exchange rate between the Russian ruble and the Us dollar basket was around 32 rubles. Now it is 48. How much of its value has ruble lost?

The answer, from DailyFX which "provides forex news and technical analysis on the trends that influence the global currency markets."

Ah, the professional advisers on foreign exchange. Here is their answer, Written by Ilya Spivak, Currency Strategist and David Rodriguez, Senior Strategist for DailyFX.com

"precipitous drop in the currency that has thus far produced losses of as much as 47.8 percent this year against the greenback"

So many people make the same mistake. Now that you know the answer is .....
you have an advantage over them.

Here is the website of the pros

2014-49 Russian monetary policy again

In the second piece in this Bloomberg TV presentation (it starts in second 22 of the clip) the change in monetary policy in Russia is described. Previously, the Russian Central bank intervened in the forex in a predictable fashion, We discussed what the bank did in posting 2014-29. Here it is:

• the band is unusually wide:  ± 12.5% (the current band is, according to the article, to keep the ruble exchange rate between 35.65 and 44.65 rubles per basket (the formulation is odd because the exchange rate is calculated against a basket of currencies, not a single currency). A more typical band is ±1% or ±2.5%
• once the exchange rate approaches a limit of the band, the central bank intervenes - this is a standard procedure. Recently the ruble was weak so the bank would intervene to prop up (increase) its value by buying rubles (i.e. increasing demand for them) and selling foreign currencies. Also standard.
• once the daily intervention reaches a limit ($350 million) the band is moved up by 0.05 ruble (5 kopecks). This mechanical rule is also unusual. 

The Bank of Russia is ending this type of intervention. Why? As the Bloomberg reporter says, it was predictable and so could be taken advantage off by speculators. The bank will still intervene, but not in a predictable way.

It looks like Russian markets are shaky The Rubble has been falling, and bond yields have been increasing. The interest rate on Russian bonds with maturity of 13 years is 10.16%.

Unfortunately, the graphs mentioned in the article are not available.

2014-48 Penalties for currency manipilation

$3.4 billion fines were imposed on UBS, HSBC, Citigroup, RBS and JP Morgan

And a big surprise:
"Dozens of dealers have been suspended or fired for sharing confidential information about client orders and coordinating trades to make money from a foreign exchange benchmark used by asset managers and corporate treasurers to value their holdings in the latest scandal to hit the financial industry."

You may ask why. Well, read the article. There is a trail of e-mails by wrongdoing dealers. Even bankers, when there is clear evidence against them, get penalized.

But if you read the article carefully, another picture emerges as well. There were complaints for some time about currency rigging. The banks did not follow up. Here is a quote: "The bank said it regretted not responding more quickly to the complaints. The other banks were similarly apologetic."
It seems bank management that failed to supervise brokers did not suffer. 

What is interesting is that this was a joint investigation of US and British authorities. Finally, they are recognizing that banking became international, and national supervision may not be enough.

And about your belief that bankers suffer penalties when they misbehave, shown by your answer to question 55 on the macro exam and question 53 on the money and banking exam:

Benefit: "“He’s sat back in his chair … announcing to desk …that’s why I got the bonus pool,” said one trader to a rival after they colluded on a rate, earning, according to regulators, a profit of $513,000 on the trade."
Penalty: "nor were any traders or executives charged with wrongdoing."

The details of how it worked are here.
In case you cannot access NYT:
The fix is the rate set over 60 seconds at 4pm in London

"The F.C.A. and C.F.T.C. claim that the traders at different banks met in online chat rooms and colluded on trading strategies, particularly in the moments before a fix was determined, so that their own banks could profit.

By making a large number of bids, or orders, ahead of the fixing time, traders could potentially send the price of a currency up or down. They then could profit from the difference in the fix price and the average price they paid for euros or other currencies throughout the trading day."

Why this should not be done:

"Regulators say that making trades to manage a bank’s risk of holding too much of one currency is permissible. But the activity uncovered in this inquiry was strictly to amass outsize profits and not in the interest of bank clients."

"In one instance, the British regulator said a trader at Citigroup made a $99,000 profit based on trades executed in a 33-second period ahead of the E.C.B. fix after colluding with traders at four other firms."

2014-47 A proposal for too-big-to-fail banks

As the Great Recession has shown some banks became too-big-to-fail. What does it mean? In the event of another financial crisis, a failure of such a bank would cause a major disruption in the world economy. So it is clear that such banks will not be allowed to fail. They will be saved by governments to prevent another meltdown of the world economy, as happened when Lehman Brothers failed.

The problem is that, the knowledge that a bank will be bailed out if it runs into problems will encourage bank management to take on excessive risk. In addition, it will reduce the bank's cost of funds, giving it an advantage over smaller banks. This would lead to a consolidation of the banking system, which is not desirable.

The solution: systematically important banks (30 banks around the world, none Canadian), will have to have more capital than smaller banks.
This accomplishes two things:
- it lowers the risk of bank failure
- it increases the cost of doing business for big banks, offsetting their lower cost of funds

2014-46 ABC

This is NOT A LESSON; this is Accountants Behaving (almost) Criminally.

Someone stole a hard drive containing agreements between the government of Luxembourg  and various companies that allowed them to use accounting tricks to reduce taxes.

Here is an example, from the International Consortium of Investigative Journalists who received and published the documents.

The leaked documents reviewed by ICIJ involve deals negotiated by PricewaterhouseCoopers, one of the world’s largest accounting firms, on behalf of hundreds of corporate clients. To qualify the companies for tax relief, the records show, PwC tax advisers helped come up with financial strategies that feature loans among sister companies and other moves designed to shift profits from one part of a corporation to another to reduce or eliminate taxable income. 

The records show, for example, that Memphis-based FedEx Corp. set up two Luxembourg affiliates to shuffle earnings from its Mexican, French and Brazilian operations to FedEx affiliates in Hong Kong. Profits moved from Mexico to Luxembourg largely as tax-free dividends. Luxembourg agreed to tax only one quarter of 1 percent of FedEx’s non-dividend income flowing through this arrangement – leaving the remaining 99.75 percent tax-free.

Interestingly enough,another organization that benefited from tax avoidance is the Public Sector Pension Investment Board (PSPIB), a Crown corporation which invests pensions of federal public servants (including RCMP!).

CBC writes about it extensively. This is the only Canadian publication shows up when I search for the story (google Public Sector Pension Investment Board International Consortium of Investigative Journalists). The story is embarrassing (I wonder if the PSPIB manages pensions of our elected representatives); the silence is odd.

2014-45 Japan tries to end a 25-year long slowdown = Abenomics

Since the collapse of the stock market and property bubble in Japan in 1989 the economy has been growing slowly. Two years ago the newly reelected prime minister Shinzo Abe embarked on an all - out effort to improve the economy. It involved three elements
- a relatively small fiscal stimulus
- a massive monetary stimulus, trying to depreciate the yen and changes to the Bank of Japan act.
- structural reforms
The program is popularly known as Abenomics
The fiscal stimulus was necessarily low since Japan has been runnning a large budget deficit in a long time and its debt to GDP ratio is second highest in the world (after Zimbabwe!). The goal of the monetary stimulus was to increase the rate of inflation to the target of 2%. Structural reforms involved reduced regulation and trying to make the labour market more flexible.
Initially the program worked well but now the Japanese economy seems to be experiencing a slowdown. This article describes the current situation.

Yen depreciation and exports. The yen has depreciated significantly, from over 1/80 of the US dollar to  under 1/110 of the US dollar in the last two years. Note that the exchange rate of the yen is essentially always given upside down, i.e. as the number of yen per dollar (which increased from under 80 to over 110 - see the graph). As a result Japanese exports have increased.

Inflation rate and wages. Inflation rate did rise.But nominal wages did not rise and so  real wages declined. This is because the labour market in Japan operates under an implicit contract: workers get jobs for life and are partially shielded from business fluctuations: their wages do not fall a lot when there is a recession, but they do not increase a lot when the economy is in good shape.

Yen depreciation and import costs. The depreciation of the yen had the negative effect of increasing prices of imported goods and the cost of imports, in particular of oil and gas needed to produce electricity, as nuclear power plants had been closed since the Fukushima earthquake in 2011.
Another problem is the planned increase in sales tax, which is to rise to 10% by the end of 2015.

New program of quantitative easing. Solution: the usual one:quantitative easing. Last week the Bank of Japan announced that it will buy $US700 billion of securities a year. That is  twice as much, compared to the size  of the economy, as the quantitative easing program that just ended in the U.S.

2014-44 Interchange fees are falling

Last week we discussed interchange fees, the fees that banks charge merchants when customers use credit cards.

It looks like banks gave up, and will reduce the fees "voluntarily". that means without government regulation.

2014-43 News from around the world

1. Europe is growing slower than expected and forecasts of future economic growth have been cut yet again.

2. The  price of oil is the lowest in four years

There are two basic reasons:

• Low demand since the world economy growth slows down
• Worries about weak growth in the future reduce prices now

3. The exchange rate of the Canadian dollar in terms of the US dollar is the lowest in five years 

There are two basic reasons:

• The Canadian economy is growing slower than the US economy
• Canada is a major oil exporter; when prices of oil fall, the Canadian dollar depreciates

2014 - 42 BBB again

I someone runs afoul of the law, and does not suffer consequences, what do you expect is going to happen?
Well, I guess it depends.
But if the law violation was VERY profitable, the chance of re-offending is high.

I thought we were done with BBB: Banks Behaving Badly. But they are not done behaving badly.

A lengthy New York Times article reports that big banks, which got away with limited penalties and were supposed to improve, went back to their bad ways.

What is happening is actually hard to believe.

1. Standard Chartered, a British bank, transferred money to countries blacklisted by the U.S. government (including Iran, which is under various sanctions related to its alleged nuclear program).
It is now accused of not disclosing the details of its wrongdoing, as it was required under the terms of the settlement.
Sanction busting is illegal under the U.S. law.
For an individual an equivalent crime would be laundering money for drug dealers of for the mafia.

2. Bank of Tokyo-Mitsubishi - same thing. Dealt with Iran, accused of under-reporting the scale of wrongdoing.

3. Barclays, UBS. They manipulated interest rates (LIBOR) - see posting 2014-20. They promised not to manipulate any more, but broke the promise by allegedly manipulating exchange rates - see postings 2014-20 and 2014-28.
For an individual an equivalent crime may be to steal from Joe, promise to give up stealing in exchange for not being sentenced and then stealing from Jane.

Do not trust my word only: here  is what the New York Times writes:
"Typically, when banks have repeatedly run afoul of the law, they have returned to business as usual with little or no additional penalty — a stark contrast to how prosecutors mete out justice for the average criminal."

4. PricewaterhouseCoopers. Hey, bankers are not the only ones. Here is what happened. To assess what went wrong at Bank of Tokyo, the bank hired PricewaterhouseCoopers and paid it to write a report. But e-mails were discovered "indicating that the consultant, PricewaterhouseCoopers, watered down the report under pressure from the bank".

For an individual an equivalent arrangement would be as follows. I am found laundering money for the mafia. I hire and pay for an accountant who writes a report for the judge. Hm, what could go wrong?

Note that, in all those cases, banks are treated as single entities. But banks do not launder money for Iran or manipulate LIBOR and exchange rates - bank employees do. There is no talk about individual responsibility. In other words, if a banker does something wrong, the employer pays a fine and that is it.

This is, of course, serious since various problems with banks and bankers contributed to the Great Recession and were supposed to be eliminated.

Now comes the 64 000 dollar question: can the financial crisis happen again?

2014-41 The exchange rate of the dollar and investment

A recent Statistics Canada study, summarized in this article, discussed Canadian investment over the last 20 years. Here are the main points:

1. Investment in structures is higher in Canada than in the US, but lower in information and telecommunication technology. Why? Canada is a resource rich country, hence high investment in structures. In the US, data - intensive sectors, in particular finance, are more important.

2. Investment in Canada grew slower than in the US when the dollar was weak (it reached its lowest value in 2002) and faster when the dollar was appreciating. Why? We import a large portion of investment goods. When the Canadian dollar depreciates, the relative price of investment goods increases, reducing investment.

3. As the dollar has been depreciating recently, this may lead to lower investment.

2014-40 End of QE3

The Federal Reserve is today likely to announce the end of the program of buying long-term securities - the so called quantitative easing 3 (QE3 - it was done twice before).  QE3 started in September 2012, with monthly purchases by the FED of $85 billion (or about $1 trillion a year). The goal was to stimulate the economy and lower unemployment to 6.5%. Unemployment did fall and, after over one year, the FED started tapering (reducing) the purchases over time; the last month it was only $15 billion.

What is uncertain is whether the FED is prepared to raise interest rates. Unemployment is below 6% and the US economy is in good shape. But while unemployment is low, employment is low as well. As a result of the recession a lot of people dropped out of the labour force.

2014-39 Interest free money

You can get money at zero interest in Sweden

Prices have been falling so the Swedish central bank lowered the interest rates as much as it could.

Everyone is worried about deflation. The Swedish central bank's target is 2% inflation.

These worries are perhaps overblown. One reason inflation is low is that oil prices have been falling. Unless you are Saudi Arabia, Russia or Iran etc, low oil prices are a good thing.

The former senior deputy governor of the Bank of Canada, Tiff Macklem, divided disinflation into a "good disinflation" and a "bad disinflation".

A good disinflation is one that is caused by positive developments in the economy. He talked about greater competition among retailers; the drop in the price of oil is another example of a good disinflation.

Bad disinflation is caused by economic weakness and lack of demand.

There is another important difference: a "good disinflation" is more likely to be temporary as it is less likely to affect expectations. When the price of oil falls, people know that they will not continue to fall forever. Once the price of oil stops falling, its effect to lower inflation will end. Since firms and households know this, they rare less likely to change their expectations of inflation.

But in case of inflation caused by economic weakness, it is not clear how long it may last. So inflation expectations are more likely to fall and the drop in inflation is more likely to be permanent.

2014-38 Regulating interchange fees

Interchange fees are the fees that merchants pay to credit card issuers whenever credit cards are used. The Canadian government sees the fees as too high and would like to have them reduced

Here is what the Globe is writing: "If fees are lowered, the banks and credit card companies could raise the interest rates they charge on these cards, jack up annual fees or make it harder for Canadians to earn loyalty points."

Looks like a no-brainer to me. Fees are incorporated into prices. This means customers who use cash bear the cost not only of profits earned by banks and by credit-card companies, but also of credit-card users' benefits. 

Who uses cash? Poor people. So the scheme is reverse Robin Hood. 

Note that the credit card market is not very competitive: two companies, Mastercard and Visa, have almost all the market. By the way, most of the interchange fee is earned by issuing banks; Mastercard and Visa get a small portion only. But they divide the market among themselves; I am not sure if there is a bank that issues both Visa and Mastercard, but that is unlikely.

2014-37 Results of the stress test in Europe

Turns out that several banks failed the test.
Recall that a stress test involves assuming very unfavourable conditions and checking if the bank has sufficient capital to survive.
Among them Monte dei Paschi di Siena. The first bank I ever went to in Italy. But I was not the first client - I am not that old.

Out of the 123 banks checked, 24 failed the test (in the sense that their capital was inadequate). The tests take a long time and, in the meantime, 10 brought up their capital to the required level, leaving 14 banks which need to raise capital within the next 9 months or be shut down.
Monte dei Paschi's problems have been known for a long time. It was listed on the stock exchange in 2000 (after over 500 years of being a private bank) and underwent rapid expansion. Then it had losses, hid them with a derivative contract and has been in trouble since they were made public in 2012.
So what else is new?
According to Eric Reguly in the Globe and Mail, the capital shortfall is not a huge problem. While more banks failed the test than a few years ago, the capital shortfall has not increased.

2014-36 No more math?

solving equations

2014-35 Bank of Canada did not change the interest rate

Today the Bank of Canada issued its  Monetary Policy Report (go here and click on the summary) and made the interest rate decision. The decision: keep interest rates unchanged. They have not been changed for 4 years - the longest since 1950s.

The Bank would raise interest rates if it expects inflation to increase, and lower them if it expects inflation to decrease, in the next year or so. Factors that lead to an increase of inflation are
- economy operating beyond potential
- booming exports
- raising raw material or food prices, in particular a raising price of oil.

The current situation is mixed:
- economy is considered to operate below potential
- US economy is growing fast, which points to raising exports to the US. Other economies are weak, but 3/4 of our exports go to the US
- oil prices have been falling, leading to lower inflation.

So - a mixed bag.

Here are the monetary policy report highlights:

Highlights
 Inflation in Canada is close to the 2 per cent target. Underlying inflationary
pressures are muted, given the persistent slack in the economy and the
continued effects of competition in the retail sector.
 The outlook is for stronger momentum in the global economy. However, the
profile is weaker than in July and is diverging across regions. Growth remains
reliant on exceptional monetary policy stimulus.
 Canada’s real GDP growth is projected to average close to 2 1/2 per cent over the
next year before slowing gradually to 2 per cent by the end of 2016.
 As the economy reaches full capacity in the second half of 2016, inflation is
projected to be about 2 per cent on a sustained basis.

2014-34 Bank regulation

Today, in money and banking class, we will ask why banks are heavily regulated. This article describes a new approach by regulators to evaluating bank soundness, a stress test

After the financial crisis bank regulators started to use stress tests for banks. A stress test involves checking if the bank would survive an adverse scenario in financial markets. There are many details; the bottom line is that the bank is assessed on the adequacy of its capital and risk management. Banks that come out lacking may be forced to increase their capital by issuing new shares or by merging with another institution; in the worse case scenario their licence may be withdrawn.

What do banks need to do to improve their assessment, and reduce the possibility of failure? Recognize bad loans, write them off and rebuild its capital.

Two points:
- the tests are not perfect: in the past, banks in Portugal and Belgium passed a test and then failed
- the US financial institutions did what they needed to do several years ago. Now the US economy is growing, while Eurozone economies are not.

2014-33 Alternative take on the decline of stock prices

The reason stock prices fell is that the easy money has been made and stocks are down on profit taking. There are more sellers than buyers and a lot of cash on the sidelines. Some analysts are cautiously optimistic about the market, others are constructive about the market but it we may be in a bottoming process. Some think stocks are oversold and it is a stockpicker's market.  So what to do? You can take a wait-and-see approach or buy on weakness but remember that this is not the stock market, it is a market of stocks.

In case you do not quite understand it do read this article. One day you may make it to CNBC

2014-32 Stock market as ebola

Stock markets fell last week (Here is TSX, you can compare it with US stock indices by clicking "compare" at the top of the graph).
How to explain this?
In 2013 Nobel prize winner in economics, Robert Schiller, received the prize for "empirical analysis of stock prizes". He explains why shares sometimes fall for no apparent reason in this article
His explanation:
- short-term variations in stock prices are extremely hard to predict
- but we should try because "we live in the present"
In his view stock prices are sometimes moved by "thought viruses" and spread by contagion, just as biological viruses.
The virus this time: well, there are three

1. global slowdown
2. deflation
3. and the big one: secular stagnation

People are concerned that the world economy entered a new phase of slow growth. In this context secular means "lasting a very long time". So this sounds serious. If there is an economic slowdown which lasts a long time, profit expectations fall, future dividends will be lower and so stocks are overpriced.

Once a lot of people get the thought virus and start selling stocks, the forecast of falling stock prices becomes self-fulfilling. Stock prices fall, people become even more concerned, sell more stocks and stocks fall further.

2014-31 How to study

And now for something completely different
No, not this one. That one

The article reviews the book How We Learn: The Surprising Truth About When, Where, and Why It Happens  which summarizes the results of years of research on how to study effectively (if you want to remember what to study)
- do not cram
- study for short periods
- change the place you study in
- review the material
- sleep on it

For more details - read the article. It is actually pretty good, in my opinion at least.

2014-30 Asset allocation in uncertain times

Even though interest rates have nowhere to go but up, they are going down
What is going on?
Interest rates are near historical lows. But, as the economy becomes shaky, there is flight to quality; Investors sell risky assets (stocks, corporate bonds) and buy less risky assets (government bonds). So prices of government bonds go up, and interest rates fall even further.

Now think about it: if it was really the case that bond returns could only increase, it would have been a sure bet. Of course there are no sure bets. So there is always a risk that the market would turn in the opposite direction. And this is what is now happening.

2014-29 How the ruble is managed

The ruble is falling for three reasons

1. sanctions by Western countries related to the aggression in the Ukraine

2. low price of oil

3. strong US dollar.

The exchange rate arrangement in Russia is a dirty float. The exchange rate is allowed to vary within a band relative to a basket of currencies, and the central bank intervenes to keep it within the band. This is not an uncommon arrangement but the details are unusual:

• the band is unusually wide:  ± 12.5% (the current band is, according to the article, to keep the ruble exchange rate between 35.65 and 44.65 rubles per basket (the formulation is odd because the exchange rate is calculated against a basket of currencies, not a single currency). A more typical band is ±1% or ±2.5%
• once the exchange rate approaches a limit of the band, the central bank intervenes - this is a standard procedure. Recently the ruble was weak so the bank would intervene to prop up (increase) its value by buying rubles (i.e. increasing demand for them) and selling foreign currencies. Also standard.
• once the daily intervention reaches a limit ($350 million) the band is moved up by 0.05 ruble (5 kopecks). This mechanical rule is also unusual. 

What does moving the band mean? That the Russian central bank does not try to prevent appreciation or depreciation but does want to prevent rapid changes in the currency. This is a bit similar to what Bank of Canada was doing before 1998.

The intervention reduces the central bank's foreign exchange reserves by $350 million. This is not a big problem since Russia has over $500 billion in reserves

Interesting factoids: 

• there are 169 countries listed on the CIA Factbook comparison of the foreign exchange reserves. The sum of those reserves is almost $13 trillion. The top four countries: China, Japan, Saudi Arabia and Switzerland hold a half of all reserves. 
• The amounts vary from $32 million in Montserrat to 100 000 as much in China. But, per person, Montserrat's reserves are twice bigger.

Here is the exchange rate of the ruble in terms of the basket of currencies (a very simple basket: US dollar has the weight of 0.55 in the basket, Euro has the weight of  0.45):

2014-28 Currency fix

In the news: currency fix. The US attorney General is investigating major banks' fixing of currency rates
The banks - about a dozen banks including  Deutsche Bank (41, 11) Citigroup (7, 14), JPMorgan Chase (2, 6), Barclays (27, 10) and UBS (21, 25). 

The first number is from ranking by market cap, the second from ranking by assets. World largest banks are here.

2014-27 The dollar is depreciating

The Canadian dollar has been depreciating recently, and fell below $0.89 (that is, CADUSD=X=0,89) on Friday. 

Reasons:

1. Strong US dollar, in part because of the relatively strong US economy

2. Weak oil prices (recall that Canada is a significant oil exporter)

3. Expectation that interest rates in Canada will not be rising soon - in part because theBank of Canada is perceived as trying to maintain expansionary monetary policy.

This is economics in action:

What happens if the US interest rates are expected to increase and Canadian rates do not? By the interest rate parity, the Canadian dollar depreciates.

The article also mentions forward contracts on the Canadian dollar. The US CFTC (Commodity Futures Trading Commission) reported that there is now a net short position in Canadian dollars. A short position means that speculators are counting on the Canadian dollar to fall. They sell the dollars they do not have (hence "short" position) for delivery at a specified date in the future. They hope that, when the contract is due, they will buy the dollars at a lower rate. The excess of short positions means speculators expect the Canadian dollar to fall.

Here is an interesting quote, somewhat difficult to understand because of the obscure language, by Camilla Sutton, chief currency strategist, Bank of Nova Scotia.

"The BoC’s tone remains conflicted, with near-target inflation limiting the ability to provide an accommodative tone and forcing a shift to focus on the potential for BoC-Fed policy divergence"  

What it means: the Bank of Canada would like to maintain low interest rates but it is going to be difficult

- inflation is near the BofC target (2%), which so the Bank of Canada cannot explain low interest rates by referring to inflation being too low;

- "accomodative tone" refers to Bank of Canada statements that low interest rates are needed 

- focus on potential of BofC-Fed policy divergence - the US is switching to a more restrictive (less accommodating) monetary policy with the end of the latest round of quantitative easing. This pushes the Bank of Canada to also be less accommodating.

2014-26 Tax dodging - updated

A few blog posts were about banksters. This post is about non-financial companies. They manage to manage their finances so that they do not pay too much tax.
For example, there is a lot of pressure on Apple to change its ways.

Here is a neat Apple's trick. The US taxes companies on the basis of where they are incorporated and Ireland taxes companies on the basis of where they are managed. Simple arrangement:  Apple Operations International is incorporated in Ireland and managed in the US. So it has not filed tax returns anywhere for the last 5 years. Between 2009 and 2012 its income was $30bln.
Apple Sales International had revenue of $74bln in 2009-2012 and claims not to be a tax resident anywhere. The tax it paid:0.05%.

More details of Apple's tax reduction methods are in this article. According to the article, in 2011 Apple paid "cash taxes" of $3.3 billion on profits of $34.2 billion (9.8%) while Walmart paid $5.9 billion on profits of $24.4 billion(24%).

Why is Apple so different from Walmart? One reason is that a large part of Apple's profits arise from its intellectual property: patents. They can be transferred to another company registered with a place with low taxes.

A commentary by a NYT columnist is here.

Before you criticize Apple's management recall that the duty of the management is maximizing shareholder value. One way to do it is to use legal means to reduce tax obligations. So the problem is not Apple, but tax laws.

2014-25 How the cost of transportation falls

In the last class I mentioned that transport costs are not the most important reasons for the law of one price not to hold. Here is an interesting story about the largest container ship in the world (18 000 of 20 ft long containers). In particular, the article mentions it is twice bigger than another ship but uses only 6% more fuel

2014-24 ECB starts quantitative easing

The ECB held its rate setting meeting and decided to keep its interest rate at 0.05% ($5 per $10 000 for a year). It also announced that it will be buying various bonds to increase liquidity in the markets and spur lending.

All this because the Eurozone economy is in poor shape:
- inflation is 0.3%; the target is "below 2%"
- growth is slow
- the Italian and German economies are shrinking

Here is what the ECB head said:

"The recovery is likely to continue to be dampened by high unemployment, sizeable unutilised capacity and continued negative bank loan growth to the private sector.

"In particular, the recent weakening in the euro area's growth momentum, alongside heightened geopolitical risk, could dampen confidence and, in particular, private investment."

2014-23 It took only 6 years

before it turned out that maybe Lehman Brothers should have been rescued by the FED

It all depended on an assessment of whether the bank was bankrupt. Turns out that there was a group of FED officials who determined it was not. It was just facing a liquidity crisis: its liabilities were more liquid than assets and it could not meet its obligations.

When a bank is solvent but faces a liquidity crisis, the central bank acts as a lender of last resort: it lends money until the bank can sell the illiquid assets and pay back the loan from the  central bank.

So some FED officials thought Lehman was bankrupt; others thought it was not. But the information that it was not did not reach the decision makers on time.

That does not look too good for the confidence in the financial system, does it?

2014-22 Kenia revises GDP

The new estimates, it is higher by a quarter!

Here is what happened:
Kenya revised its data to take account of expanding industries such as mobile-phone money transfers and informal businesses, while also changing the base year of the figures to 2009 from 2001

- adding expanding industries - good
- adding informal businesses - many countries start doing it (recall that Italy is adding prostitution and drugs to GDP, per EU directive)
- changing the base year - should make no difference.

2014-21 Exchange rate in action

In today's report, Bloomberg writes about what is happening with the ruble exchange rate and exchange rate policy

• the ruble has been falling because  of sanctions imposed on Russia by developed countries (US, Canada, Australia, Japan and European Union) resulting from its aggression in Ukraine
• sanctions raise uncertainty, making Russian assets less attractive. So two things happen: 

1. capital flows out of the country
2. interest rates increase

• Russia has ample foreign exchange reserves: $515 billion in 2013 according to CIA Factbook (for comparison, US has $150 bln, Canada has 70 bln of reserves and China has $4 trillion)
• the current system of exchange rate management in Russia is as follows:

1. there is a basket of currencies in terms of which the ruble is controlled
2. the ruble is allowed to move within a band
3. if it crosses the band, the central bank sells or buys rubles on the foreign exchange market

• Russia is considering:

1. Introducing capital controls to stem the outflow of capital (one specialist says this will not happen until reserves start falling by $20 bln a month)
2. Flexible exchange rates

Here is an important sentence:
The central bank widened the ruble’s trading band in August as it prepares for the shift to a freely floating ruble, abandoning a 15-year policy of tapping reserves to control currency movements in favor of using interest rates to manage inflation. 

What it means:
- current monetary policy is to manage the exchange rate, by intervening on the foreign exchange market
- they want to switch to flexible exchange rates and use monetary  policy to manage inflation, by changing interest rates (like, for example, Bank of Canada does)

What it stresses:
-they can either control exchange rates or the inflation rate, but not both at the same time. Monetary policy can accomplish only one thing at a time.

2014-20 Banksters

Two more stories today about banksters:
- manipulation of Libor - wow, people got fired and lost unpaid bonuses. What about paid bonuses?
- manipulation of foreign exchange rates

The BBC website is excellent since they actually explain things

Here is an explanation of LIBOR
1. banks submit estimates how much they would pay to borrow from other banks. The estimates submitted were sometimes false, to promote the interest of the submitters.

Oh, I understand now. So the market was organized on the interesting idea that bankers will provide truthful information.

Oh, not another smiling monkey.
OK

2. And how much depends on LIBOR?
Contracts worth $300 000 000 000 000

Here is an explanation of the forex scandal

By the way, according to the article the forex market is now over $5 trillion a day.

2014-19 Interest rates and bond prices

Interest rates are at record lows and will, eventually, increase. This means bond prices will fall

IMPORTANT: we will be studying the relationship between interest rates and bond prices later on in the course. Since a lot of students are unclear about the relationship, it is a good to think about it ahead of time.

1. What is a bond? It is a promise to pay predetermined amounts of money in the future. 
2. What determines the price of a bond? The amount you need to generate future payments identical to the payments the bond will provide.
3. How to avoid a mistake? Bu remembering that, once the bond is sold for the first time, the price at which it is sold is irrelevant.

I will provide a simple example, of a consol. A consol is a bond that has no maturity day. It pays the interest forever. It is easier to analyze a consol since you do not need to consider a maturity date.
In the example, the consol has a face value of $100, pays 5% per year, and sells for $100.

The points below correspond to the points above

1. The consol will pay the owner $5 per year forever.
2. How much do you need to earn $5 per year? 

- if the interest rate is 5%, you need $100. You deposit $100 in the bank and get 5% of $100, or $5 per year

- if the interest rate is 2.5%, you need $200. You deposit $100 in the bank and get 2.5% of $200, or $5 per year

- if the interest rate is 10%, you need   $50. You deposit $50 in the bank and get 10% of $50, or $5 per year.

So if the interest rate is 2.5% the price of the consol is $200, if the interest rate is 5% the face value of the consol is $100 and when the interest rate is 6.2% the price of a consol is - well, you can calculate it yourself

     3. To calculate the price of the consol, we took two things into account: the yearly payment, and the interest rate. The price at which the consol sold, nor the face value, entered into the calculation. As often happens, the consol could sell for $99 (at a discount) or for $101 (at a premium) - without affecting the price of the consol later on. Similarly, a consol with a face value of, for example, $120 which happens to pay $5 per year would have the same price as a consol with the face value of $100 which pays$5 per year.

2014-18 Innovations in lending

According to the New York Times article there is a new technology in town. Lenders providing car loans install a device that allows them to disable the car remotedly. This reduces the number of loan defaults and so allows them to extend credit to people who were considered too risky in the past.

As a result, the proportion of car loans that are subprime has been increasing, although it has not reached the pre-recessions levels, as you can see on the graph further in the article.

Conclusion: technology can improve the functioning of credit markets.

Of course people who use subprime loans are poor, not financially educated and can be exploited by unscrupulous lenders. But that is a separate problem.

2014-17 It was a slow news day until I found that a bank was fined $850 000

A small Swiss bank was fined for providing trading in offshore places to BC residents even though it was not registered. The services allowed some BC residents to do trades without disclosing their identity.

Two points:
- governments around the world have been trying to reduce the amount of money hidden in tax heavens to avoid taxes
-  Here are some other bank fines totals since 2009:

And here are the 10 biggest fines in the US, with explanations what happened

And here is the number of senior bankers who went to jail

2014-16 Do as Canada did

The finance ministers of the G20 group of countries just met in Brisbane, Australia. Canada's finance minister, Joe Oliver, said what we have already discussed: that the world economy is in poor shape. He also encouraged European governments to follow Canadian example by, in his words (I put it in a list):
“- promoting pro-growth policies,
- driving demand at home,
- aggressively pursuing free-trade agreements,
- enhancing job-matching services,
 - increasing the participation of all groups in the workforce and
- enhancing private-sector competition.”

2014-15 Women and central banking

Central banks are places full of men.

Carolyn Wilkins is the first woman to sign Canadian banknotes
You can read the discussion of the virtues of her signature's looks.
And now for something entirely different. Here is the original signature of the guy who signs US banknotes

On the other hand a woman, Janel Yellen, is the chair of the Federal Reserve

2014-14 A word from a WLU econ graduate

The new Senior Deputy Governor of the Bank of Canada, Carolyn Wilkins, BA '87, delivered her first policy speech. She said that the "neutral interest rate" has fallen from 4.5% to 5.5% in 2000s to 3%-4%

What is the neutral interest rate? In her own words, “The neutral rate is to economists what dark matter is to physicists. We are convinced it exists, it plays a central role in our models and analysis, but we can¹t directly observe it.”

Well, actually we do not know the value. What she calls the "neutral" interest rate is the rate which the Bank of Canada should maintain when the economy is operating at capacity (i.e. when output equal potential output, or the unemployment rate equals the natural unemployment rate). With such rate at full employment, inflation will be stable.

She also mentioned that the Bank of Canada does not know when the economy will return to full employment.

Two morals of that story:
1. The effects of the Great Recession will linger for quite some time
2. The Bank of Canada does not know what interest rate it should set or when. That makes the task of monetary policy difficult, wouldn't you say?

By the way, the Globe and Mail article is more detailed, but gremlins struck again. At the beginning of the article they write: " "3 to 4 per cent,” roughly 1.5 percentage points below its historical norm", at the end they write  " the historical norm of about 4 per cent". Go figure.

2014-13 Stocks and flows again

In post 2014-09 I talked about mistakes in comparing stocks and flows. Here is a good illustration, although the author of this Globe and Mail article actually may have remembered something from an economics class.
He compares foreign direct investment inflows with GDP. Sounds right: he compares flows with flows.

But while he writes about FDI inflows, he uses data on FDI stocks. So he does end up comparing the stock of direct foreign investment with GDP (a flow).

How bad is it? In a word: terrible. This is the main Saturday business article - two solid pages. According to the article, in some contries the "flow" of FDI is larger than GDP. That does not make any sense, since total investment in a country is a fraction of GDP (in Canada around 20%).

Is it difficult to find actual data? Not at all. Here is what I found googling OECD FDI (since he claims the data are from an OECD report) - see page 7. Here is the page from Wikipedia

The moral of the story: when you read something - think whether it makes sense. And the moral of the story for the Globe - not good

2014-12 US monetary policy is changing - but slowly

The Federal Reserve, the US central bank, has just finished its policy meeting. These meetings are held 8 times a year. They provide two things:
- decision in interest rates and other monetary policy measures
- description of what the Federal Reserve thinks is, and will, be happening in the economy and how it may react.
Not much in terms of news this time. The Federal Reserve confirmed that in October it is ending its  quantitative easing program which involved large scale purchases of securities in order to increase liquidity in the market and encourage lending.
It also provided forward guidance: it will start increasing interest rates next year but, for now, interest rates will remain low.

2014-11 Canada's exchange rate

In a speech on Tuesday the governor of the Bank of Canada denied rumours that the bank was trying to depreciate the dollar. 
He said Canada does better with a floating exchange rate. Controlling the exchange rate would lead to greater fluctuations in output, inflation and unemployment.
Why? If the exchange rate is controlled and, for example, demand changes, then output and employment need to adjust. If the exchange rate is floating, it does some of the adjustment.
So the Bank of Canada targets inflation and the exchange rate is set by the market.
As we will discuss in chapter 4, the central bank cannot control the inflation rate and the exchange rate at the same time. It must choose one and let the other be determined by market forces.

2014-10 The world economy is growing slower than expected

The OECD - Organization of Economic Cooperation and Development, has published a new report.
Growth forecasts have been reduced for Canada, the Eurozone and the U.S., unchanged for China, and increased for India. The report provides statistics, but not explanation.
So: the world economy is bad. But not that bad. This is an example of how not to illustrate a story

OECD, in its report, said that the European Central Bank (ECB) should, to stimulate the lagging Eurozone economy, engage in quantitative easing: purchases of various long-term assets from banks and other financial institutions. As you may recall, this was the topic of the first two entries this year: 2014-01 and 2014-02. OECD is saying they should do more. In practice this means the ECB should buy sovereign (i.e. government) bonds of Eurozone countries, as the markets for asset-based securities are small.

Here is an illustration, from the Economist, of how the stimulus from the ECB has been lagging behind:

By the way, this week the Federal Reserve holds its meeting and will likely announce the end of its program of quantitative easing. The easing, which involved the purchases of securities for up to$85 billion a month, can be seen in the graph above, as the increase in the Federal Reserve balance sheet since 2013.

2014-09 What every economics and business student should know

Here is  list of what Apple is worth more than

Should you know the details? Of course not. You should know which of the items on the list involve wrong comparisons.

Hint: cannot compare stocks and flows.  Why? Here is an example: you are going on a trip. The distance you will be driving is 90km. You are driving on a highway and doing 110. What is bigger: the distance you are driving or the speed with which you are driving? (see the hint at the end of this post).

The value (market cap) of Apple is a stock; many things listed on this website are flows. For example:

1. US stock market in 1977 - stock, so this is ok
2. annual prescription drug sales - flow. Wrong
3. 300 years of Irish beer consumption - that is a difficult one. The way I would read it is: the amount of beer the Irish drank between 1714 and 2014, That is a stock, OK.  (On the other hand, if the question was: it is worth more than the beer Irish drink over a period of 300 years, that would be a flow (per 300 years) - flow. Wrong)
4. Construction of interstate highways - stock,OK
5. Worldwide lottery sales - flow. Wrong
6. Global coffee industry There are two comparisons here:

The global coffee industry employ some 25 million people and generates $70 billion dollars a year. With a market cap of over $400 billion, Apple is worth more than 5 years of the coffee industry. In addition, Apple’s $46 billion in revenue in the last quarter eclipses the United States coffee industry value, estimated at $19 billion.

The first one compares Apple market cap: $400 bln, which is a stock, with 5 years of coffee sales, which is a flow. Wrong

The second compares Apple revenue - a flow, with the US coffee industry value. If this means the value of coffee sales, it is a flow so the comparison is ok. If that means the value of coffee companies in the US, that is a stock and the comparison is wrong.

The problems are two:

- the one you should avoid: mixing up stock and flows

- imprecise language. When you are driving and doing 110, you are driving 110 km/hour.