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