As you may have noticed, I tend to show you various errors so that you do not make them in the future. In a commentary to the Statistics Canada report discussed in the previous post, Canadian Business makes two mistakes that are instructive. They provide the dollar estimates of the underground economy ($18.8 billion in 1992 and $35.7 billion in 2008). These numbers are meaningless, since they are in current, and not in constant dollars.
Canadian business estimates what would have happened if all the underground activities had been taxed and all extra proceeds were used to reduce the deficit. This is naive: government spending does depend on its revenue. So the assumption that all the extra revenue would have been saved by the government is incorrect.
This type of reasoning is quite common. Something changes and the writer assumes all the effects fall on one thing only. But the economy is an interconnected system; if one thing changes, a lot of others do as well.
Wednesday, 19 September 2012
8. Underground economy
In this and the next lecture we will be discussing GDP. One of the things not included in GDP is the underground economy. Globe and Mail reported on 19/9/2012 that most Canadians have paid under the table to avoid taxes. No surprise there. The article references a Statistics Canada report (the link in the paper is bad; to find the report Google: Estimating the Underground Economy in Canada, 1992-2008, click on the www.carpenters.org link - it is from the United Brotherhood of Carpenters - now, that is funny: why would carpenters read a report on paying under the table?). Big surprise here: the underground economy in Canada is only 2.2% of GDP. The estimates I have seen are much higher. An IMF article, provides estimates for 1990 using several methods; for Canada the size of the underground economy is between 10% and 13.5%, depending on the method. The difference may be due to the fact that the Statistics Canada report does not include illegal activities.
4.The effect of iphone5 on US GDP
I repeat here for your convenience the posting from mylearningspace. We talked about it last Thursday; I have updated it by what I have learned since then.
The calculation was not a journalistic mistake, as I thought. It was made by the chief economist of JP Morgan, the largest US bank. Here it is. I wrote to him and got an answer that is cited below.
1. Here is the calculation. Mr. Feroli, the chief economist, expects that 8 million of iphones 5 will be sold in the US in the 4th quarter. He thinks the price will be $600, of which $200 will be imported (they call it "imported cost component" , a typical gibberish of financial analysts). In economics we say that,in the production of iphone, $200 is produced outside of the US (and so does not count as US GDP) and $400 is produced in the US (and so counts in US GDP). The value of the portion of iphones produced in the US is 8 million times $400 = $3.2billion in a quarter, or $12.8bln in a year. Somehow this becomes 0.33% of US GDP. This is not correct. The US GDP is around $15 trillion so iphone5 contribution to US GDP is a bit less than 0.1%.
2. Should the analyst subtract the number of iphones 4 sold in the 4th quarter of 2011? Of course he should. The contribution to growth is not the level of production, but the change in the level of production.
What is going on? Hard to say. I actually have not seen anything like it before. Everyone made the same mistake, including a Nobel Prize winner Paul Krugman (it is clear from what he writes that he did not check the calculations).
It is a good example of the need to check what you read.
As business students you should be numerate.
*********************
Here is more on this topic. I wrote to Mr. Feroli that I have difficulty replicating his calculations. By my calculations, to increase growth by 0.33% of GDP, i.e. $12 450bln = 0.33% * $3 773bln (US GDP per quarter was, according to IMF, 15 090bln/4=3 773bln), the sales of iphones must be higher by 31 million =$12 450bln/$400 in Q4 2012 than in Q4 2011.
His reply: "Our apple analyst is of the belief that price-cutting on the 4 and 4s will actually lead to some increase in sales of previous generations"
That cannot explain the effect.
Writing this I realized what went wrong. I suspect the following:
JP Morgan took the value of GDP in 2011 ($15 090bln or $3 773bln a quarter),
added 3% for growth of nominal GDP and obtained, for Q4 2012, $3 885bln,
for some reason they divided this by 4 again, obtaining $971bln,
they calculated the value of the iphones produced in the quarter: $400*8 mln =$3.2bln,
dividing $3.2bln by $971bln they got 0.33%.
So there were two mistakes:
1. they got confused by quarters and years
2. they forgot that growth means the difference between this year and last, and calculated not extra growth, but extra GDP.
Well, do not laugh at them. As I wrote, every news organization, plus a Nobel laureate, copied it without noticing the error. Let us call it the Apple Awe
Two definitions of the word awe:
I am not sure where the 8 million estimate for Q4 2012 came from.
The calculation was not a journalistic mistake, as I thought. It was made by the chief economist of JP Morgan, the largest US bank. Here it is. I wrote to him and got an answer that is cited below.
1. Here is the calculation. Mr. Feroli, the chief economist, expects that 8 million of iphones 5 will be sold in the US in the 4th quarter. He thinks the price will be $600, of which $200 will be imported (they call it "imported cost component" , a typical gibberish of financial analysts). In economics we say that,in the production of iphone, $200 is produced outside of the US (and so does not count as US GDP) and $400 is produced in the US (and so counts in US GDP). The value of the portion of iphones produced in the US is 8 million times $400 = $3.2billion in a quarter, or $12.8bln in a year. Somehow this becomes 0.33% of US GDP. This is not correct. The US GDP is around $15 trillion so iphone5 contribution to US GDP is a bit less than 0.1%.
2. Should the analyst subtract the number of iphones 4 sold in the 4th quarter of 2011? Of course he should. The contribution to growth is not the level of production, but the change in the level of production.
What is going on? Hard to say. I actually have not seen anything like it before. Everyone made the same mistake, including a Nobel Prize winner Paul Krugman (it is clear from what he writes that he did not check the calculations).
It is a good example of the need to check what you read.
As business students you should be numerate.
*********************
Here is more on this topic. I wrote to Mr. Feroli that I have difficulty replicating his calculations. By my calculations, to increase growth by 0.33% of GDP, i.e. $12 450bln = 0.33% * $3 773bln (US GDP per quarter was, according to IMF, 15 090bln/4=3 773bln), the sales of iphones must be higher by 31 million =$12 450bln/$400 in Q4 2012 than in Q4 2011.
His reply: "Our apple analyst is of the belief that price-cutting on the 4 and 4s will actually lead to some increase in sales of previous generations"
That cannot explain the effect.
Writing this I realized what went wrong. I suspect the following:
JP Morgan took the value of GDP in 2011 ($15 090bln or $3 773bln a quarter),
added 3% for growth of nominal GDP and obtained, for Q4 2012, $3 885bln,
for some reason they divided this by 4 again, obtaining $971bln,
they calculated the value of the iphones produced in the quarter: $400*8 mln =$3.2bln,
dividing $3.2bln by $971bln they got 0.33%.
So there were two mistakes:
1. they got confused by quarters and years
2. they forgot that growth means the difference between this year and last, and calculated not extra growth, but extra GDP.
Well, do not laugh at them. As I wrote, every news organization, plus a Nobel laureate, copied it without noticing the error. Let us call it the Apple Awe
Two definitions of the word awe:
- From Wikipedia: Awe is an emotion comparable to wonder but less joyous, and more fearful or respectful.
- From dictionary.reference.com: an overwhelming feeling of reverence, admiration, fear, etc., produced by that which is grand, sublime, extremely powerful, or the like: in awe of God; in awe of ...
I am not sure where the 8 million estimate for Q4 2012 came from.
7. Why the US economy is weak
A typical recession lasts about a year and its followed by rapid expansion as firms rebuild inventories and consumers make up for delayed purchases. But not in the Great Recession. The rapid expansion never came, unemployment is still significantly higher than before the recession and the US economy is weak. Why? Because it is a financial recession brought about by housing and spending boom. US households are saving to reduce their debts (they are deleveraging and consumer spending is weak. Since consumer spending is about 2/3 of US economy, without growing consumption the economy is sluggish.
Monday, 17 September 2012
6. Non-recourse loans
Today we will be talking about one reason so many US households defaulted on their loans: in the US, the loans are non-recourse. The loan is secured by property only and the lender cannot take over other assets of a defaulting household. The only penalty then is a bad credit rating. In Wednesday's New York Times there is an article that provides details. Some defaulting households can get another mortgage after as little as 2 years.
In contrast, in other countries the borrower is responsible with the rest of her assets. I once read a sad story of a Peruvian immigrant inn Spain. He bought a house near the peak of the boom which, in Spain, was much bigger than in the US. He could not pay the mortgage so he defaulted. The bank took over the house and sold it very cheaply. He ended up without a house but with a huge debt: he was responsible for the different between what he owed minus the (low) price the bank got. He was thinking of giving up and going back to Peru but, as I recall, he could not escape the debt because of an agreement between Peru and Spain. He lost everything he had and could not afford to go home.
The different treatment of loans is the reason that, while US households default often, European households do not.
In contrast, in other countries the borrower is responsible with the rest of her assets. I once read a sad story of a Peruvian immigrant inn Spain. He bought a house near the peak of the boom which, in Spain, was much bigger than in the US. He could not pay the mortgage so he defaulted. The bank took over the house and sold it very cheaply. He ended up without a house but with a huge debt: he was responsible for the different between what he owed minus the (low) price the bank got. He was thinking of giving up and going back to Peru but, as I recall, he could not escape the debt because of an agreement between Peru and Spain. He lost everything he had and could not afford to go home.
The different treatment of loans is the reason that, while US households default often, European households do not.
5. To QE3
The FED on Thursday announced two things:
1. QE3: they will be buying mortgage based securities to raise their price and reduce long term interest rates. Unlike the two previous round, there is no fixed amount of purchases set; the FED will do it for as long as it takes to get economy growing.
2. They also announced that they will not stop when the economy starts growing, but will continue for a "considerable time" to make sure that, when the monetary stimulus ends, the economy will continue to grow.
1. QE3: they will be buying mortgage based securities to raise their price and reduce long term interest rates. Unlike the two previous round, there is no fixed amount of purchases set; the FED will do it for as long as it takes to get economy growing.
2. They also announced that they will not stop when the economy starts growing, but will continue for a "considerable time" to make sure that, when the monetary stimulus ends, the economy will continue to grow.
3. The good judge did it before
when he rejected a $33 million settlement between SEC and the Bank of America. (in the end he approved a $150million
settlement).
A bit of background. On the crucial weekend
of Sep 13-14 2008, Bank of America agreed to acquire Merill Lynch, the third
largest investment bank in the world. The acquisition had to be approved by
shareholders. The Bank was sued since it did
not disclose, prior to the vote, that it agreed to bonus payments at
Merill Lynch of $5.8bln (in the end $3.6bln was paid). Another issue was that
the bank did not disclose expected Merill Lynch losses ($15bln) prior to the
vote (the details are here).
Judge Rakoff complained that any fines paid
by the bank hurt shareholders, who had nothing to do with the lack of disclosure.
Guess what: "Bank of America said it
was pleased with today’s decision.[...] Bank of America rose 40 cents to $16.28
as of 2:38 p.m. in composite trading on the New York Stock Exchange."
(source: see above).
Sum up: by Geto Boys Geto Boys; just replace "gangsta" with "banksta" (the term bankster was coined, as far as I know, by the Economist).
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