It worries us when politicians think they know all about economics. Even more worrisome, is when they actively go out and fight for what they “believe in”.
An interestingly incredible night last week sparked my curiosity for a certain former B.C premier, Mister Bill Vander Zalm. I just didn’t expect to be so disappointed in his views. For one, he is a strong advocate against the harmonized sales tax.
From an article in the Globe and Mail, he is quoted as saying:
““We have to put up the fight,” he said. “We are going to win it, there is no doubt about it but even if we don't, the fact that we are showing the government that people are concerned, that in itself carries a very important message.”
For the full article, click here.
First a little background on income vs consumption taxes.
The benefit of consumption taxes over income taxes is that they do not distort the intertemporal allocation of consumption. Taxes are only assessed on any income that is consumed (spent on goods, services, etc.) while not taxing savings. This encourages people to save more, increasing investments and economic growth.
An income tax, however, creates a distortion between the value of a person’s labour and what they actually receive, leading to a disincentive to work. In other words, an income tax produce fewer saving (because capital is taxed), reduces investment, discourages innovation, and eventually results in a lower standard of living when compared to a pure consumption tax.
So with the Canadian federal debt at somewhere along the lines of $526 000 000 000, do we cut spending or raise taxes? No one wants to cut spending so we are left with tax increases. The HST is collected by the federal government, not the provincial one and it would make sense that it is then efficient. The input tax credit on the HST causes input costs for firms to go down and they no longer pay PST on inputs. A good example would be glasses, tables etc in restaurants. In a recession this would stimulate investment.
We do want to note that yes, some prices will increase, which is required. After all, we don’t wangt to be Greece.
Sunday, May 30, 2010
Saturday, May 29, 2010
Just how much does it cost to buy a Billy?
Not a "Billy goat" ... we did that in a previous post. Today we are talking about the staple in every young person's home ... the Billy bookcase from IKEA. The online catalogue lists the basic bookcase at $69.99 and we know a lot of accountants that will tell you that the cost of the bookcase is therefore $69.99 plus tax.
Of course, accountants never get the 'cost' thing right. We found an article in this morning's online version of the Globe and Mail explaining the apparent consumer infatuation with the big box retailer. Click here for the article. There is one paragraph, in particular, that caught our attention:
"The chain also offers unusual perks like a supervised kids’ play area and impossibly cheap specials (Swedish meatballs: $2.99!) in its cafeteria. Ikea customers understand the deal: Those treats are just a way of keeping them in the store longer. They save money at Ikea, but they have to go to work themselves to get the savings. Shoppers invest hours driving to the store, finding a parking spot, wandering the showroom, searching for staff, waiting at the cashier, hauling the flat-packs to the car and then, once home, mastering the art of the Allen key to assemble the stuff—only to discover that a part is missing." (How Ikea Seduces Us, Marina Strauss, Globe and Mail ROB Magazine, May 27, 2010 Accessed May 28,2010)
Let's assume that from home to IKEA and back, all tolled, is 2 hours. Add another hour to put the bookcase together. How much did the bookcase cost? Depends on the opportunity cost of time. (See chapter 1 of any economic principles book). If your time is worth $15 per hour, the $70 bookcase costs $115. If your time is worth $100 per hour, the $70 bookcase costs $370. We're not sure that $2.99 Swedish meatballs is enough compensation.
It would be interesting to see IKEA's data on revenues by postal code, information they collect at the checkouts. The further you have to travel to get to IKEA and the higher you value your time, the more expensive the bookcase becomes and the less likely you are to purchase it. Our guess is that customer visits decreases with the average income in the postal code (information available from the census) and also decreases with distance from the store. However, spending per customer visit likely increases with distance as consumers spread the fixed cost of travel over more goods.
Anyone surprised that income elasticity should be negative?
Of course, accountants never get the 'cost' thing right. We found an article in this morning's online version of the Globe and Mail explaining the apparent consumer infatuation with the big box retailer. Click here for the article. There is one paragraph, in particular, that caught our attention:
"The chain also offers unusual perks like a supervised kids’ play area and impossibly cheap specials (Swedish meatballs: $2.99!) in its cafeteria. Ikea customers understand the deal: Those treats are just a way of keeping them in the store longer. They save money at Ikea, but they have to go to work themselves to get the savings. Shoppers invest hours driving to the store, finding a parking spot, wandering the showroom, searching for staff, waiting at the cashier, hauling the flat-packs to the car and then, once home, mastering the art of the Allen key to assemble the stuff—only to discover that a part is missing." (How Ikea Seduces Us, Marina Strauss, Globe and Mail ROB Magazine, May 27, 2010 Accessed May 28,2010)
Let's assume that from home to IKEA and back, all tolled, is 2 hours. Add another hour to put the bookcase together. How much did the bookcase cost? Depends on the opportunity cost of time. (See chapter 1 of any economic principles book). If your time is worth $15 per hour, the $70 bookcase costs $115. If your time is worth $100 per hour, the $70 bookcase costs $370. We're not sure that $2.99 Swedish meatballs is enough compensation.
It would be interesting to see IKEA's data on revenues by postal code, information they collect at the checkouts. The further you have to travel to get to IKEA and the higher you value your time, the more expensive the bookcase becomes and the less likely you are to purchase it. Our guess is that customer visits decreases with the average income in the postal code (information available from the census) and also decreases with distance from the store. However, spending per customer visit likely increases with distance as consumers spread the fixed cost of travel over more goods.
Anyone surprised that income elasticity should be negative?
Thursday, May 27, 2010
Diversification
One of the reasons that the Canadian banking system survived the carnage associated with the global credit crunch precipitated by the collapse of the Asset Backed Commercial Paper(ACBP)market was the scope and scale of financial regulation in this country. A system now being looked at by other countries. There is plenty of material written on this topic, so we will not.
Another reason is the geographic diversity in this country. Unlike the United States that uses a unit banking system - lots of small, geographically isolated banks with few branches, Canada uses a branch banking system - a relativel small number of banks with a multitude of branches. Canada has six dominant banks that operate from coast to coast. This allows then to diversify their loan portfolios across different geographic regions.
Portfolio theory tells us that adding assets to a portfolio reduces the riskiness of the portfolio provided that the returns on the additional assets are less than perfectly correlated. The probability of a loan default in Halifax is independent of a loan default in Calgary. This is because the economies of the two regions are independent of each other. Canadian banks are large and geographically diversified thus reducing the default risk of their loan portfolios.
The idea of diversification applies to other areas as well. Firms can choose unrelated product lines to diversify their revenue streams. Look, for example, at Canadian Tire's purchase of Mark's Work Warehouse. (Some will argue that shareholders can adequately diversify their own portfolios so firms need not venture too far from their core business - but we digress).
This brings us to an article that appeared in this morning's Globe and Mail. In an upscale night club in South Africa, you will not be admitted if you are wearing running shoes. There is, however, a local hot dog vendor that will rent you a pair of dress shoes for the evening. Now that is diversification.
Would you like mustard with those stilletos?
Another reason is the geographic diversity in this country. Unlike the United States that uses a unit banking system - lots of small, geographically isolated banks with few branches, Canada uses a branch banking system - a relativel small number of banks with a multitude of branches. Canada has six dominant banks that operate from coast to coast. This allows then to diversify their loan portfolios across different geographic regions.
Portfolio theory tells us that adding assets to a portfolio reduces the riskiness of the portfolio provided that the returns on the additional assets are less than perfectly correlated. The probability of a loan default in Halifax is independent of a loan default in Calgary. This is because the economies of the two regions are independent of each other. Canadian banks are large and geographically diversified thus reducing the default risk of their loan portfolios.
The idea of diversification applies to other areas as well. Firms can choose unrelated product lines to diversify their revenue streams. Look, for example, at Canadian Tire's purchase of Mark's Work Warehouse. (Some will argue that shareholders can adequately diversify their own portfolios so firms need not venture too far from their core business - but we digress).
This brings us to an article that appeared in this morning's Globe and Mail. In an upscale night club in South Africa, you will not be admitted if you are wearing running shoes. There is, however, a local hot dog vendor that will rent you a pair of dress shoes for the evening. Now that is diversification.
Would you like mustard with those stilletos?
Sunday, May 23, 2010
Why Don't Politicians Understand Economics??????
We're sure that Langley Council will be happy to hear that they are not the only ones that don't understand economics.
An article from the German news service Deutche Welle says that the German Federal Court has told Ryanair that they are not permitted to charge customers a fee for using debit or credit cards when purchasing tickets in that country. Click here for the article.
It is, apparently, justifiable for banks to charge the airline if they accept debit or credit cards but not okay for the airline to pass those fees onto the traveller.
Every microeconomics textbook we have ever read suggests that price is determined by the marginal cost and the elasticity of demand. Bank fees are a marginal cost and we expect that those fees increase ticket prices.
So, the likely outcome? Ryanair will increase airfares by an amount equal to the surcharge that they were going to impliment (1.50-4.00 euros). That way they will satisfy the German court and paradoxically increase profits by charging passengers that don't pay with debit or credit cards.
An article from the German news service Deutche Welle says that the German Federal Court has told Ryanair that they are not permitted to charge customers a fee for using debit or credit cards when purchasing tickets in that country. Click here for the article.
It is, apparently, justifiable for banks to charge the airline if they accept debit or credit cards but not okay for the airline to pass those fees onto the traveller.
Every microeconomics textbook we have ever read suggests that price is determined by the marginal cost and the elasticity of demand. Bank fees are a marginal cost and we expect that those fees increase ticket prices.
So, the likely outcome? Ryanair will increase airfares by an amount equal to the surcharge that they were going to impliment (1.50-4.00 euros). That way they will satisfy the German court and paradoxically increase profits by charging passengers that don't pay with debit or credit cards.
Friday, May 21, 2010
Municipal Math
Maybe one more comment on the Langley fill farming.
The Township of Langley is going to hire two "soil police" to monitor the fill farming situation that we recently wrote about. Now, we know that math is a very difficult subject for most people, but with the aid of our BA-II Plus calculator we came up with the following analysis:
The two new bylaw enforcement officers will cost the Township $80,000 each per year: total $160,000. To keep costs down, we will assume they use public transit to get from fill site to fill site.
Each year the Township receives an average of 75 permit applications. If all 75 are approved, and all 75 violate the terms of their permits, and all 75 are caught by the soil police, and all pay their $750 fines without fighting them in court, then the $160,000 spent on enforcement generates $56,250 per year in revenue.
And the Township expects to pay the $160,000 cost with the proceeds of the fines.
Some may suggest that there are law abiding citizens out there and that the number of violators will be less than 100%. But there is another part of the story that almost guarantees 100% violation. Each operator of a fill site must submit monthly engineer reports. If the engineer's report costs more than $750, it will be cheaper to pay the fine.
And residents of Langley wonder why they got a 4.5% tax increase.
See the article in the Langley Times.
The Township of Langley is going to hire two "soil police" to monitor the fill farming situation that we recently wrote about. Now, we know that math is a very difficult subject for most people, but with the aid of our BA-II Plus calculator we came up with the following analysis:
The two new bylaw enforcement officers will cost the Township $80,000 each per year: total $160,000. To keep costs down, we will assume they use public transit to get from fill site to fill site.
Each year the Township receives an average of 75 permit applications. If all 75 are approved, and all 75 violate the terms of their permits, and all 75 are caught by the soil police, and all pay their $750 fines without fighting them in court, then the $160,000 spent on enforcement generates $56,250 per year in revenue.
And the Township expects to pay the $160,000 cost with the proceeds of the fines.
Some may suggest that there are law abiding citizens out there and that the number of violators will be less than 100%. But there is another part of the story that almost guarantees 100% violation. Each operator of a fill site must submit monthly engineer reports. If the engineer's report costs more than $750, it will be cheaper to pay the fine.
And residents of Langley wonder why they got a 4.5% tax increase.
See the article in the Langley Times.
Monetary Policy Made Easy
Two articles in the Globe and Mail today show just how easy it is to predict monetary policy - specifically changes in the interest rate.
The first explains that the core inflation rate has risen to 1.9% according to Statistics Canada. Since the objective of the Bank of Canada is to keep inflation at a target rate of 2% (plus or minus 1%), this upward movement in the inflation rate signals a forthcoming increase in the target overnight rate - currently 0.25%.
The second explains that the week long slide in stock prices around the world is indicative of slower growth in the global economy. This causes less exports for Canada, weakening our economy and raising unemployment. The monetary response in this case is to not raise interest rates.
So there you have it. Interest rates will either go up ... or they won't. What's so difficult to understand?
Next week, we'll predict the weather.
The first explains that the core inflation rate has risen to 1.9% according to Statistics Canada. Since the objective of the Bank of Canada is to keep inflation at a target rate of 2% (plus or minus 1%), this upward movement in the inflation rate signals a forthcoming increase in the target overnight rate - currently 0.25%.
The second explains that the week long slide in stock prices around the world is indicative of slower growth in the global economy. This causes less exports for Canada, weakening our economy and raising unemployment. The monetary response in this case is to not raise interest rates.
So there you have it. Interest rates will either go up ... or they won't. What's so difficult to understand?
Next week, we'll predict the weather.
Thursday, May 20, 2010
The Case for Smart Meters
We came across an article in the Wall Street Journal that explained some of the features of ‘Smart’ electricity meters. Unlike conventional meters that record the usage of electricity on an aggregate basis, smart meters measure consumption by time and day. Using a conventional meter means paying the average price for the month. Using a smart meter means paying spot prices on a continual basis. That means that electricity is more expensive between 4 and 6 pm than it is from 2 to 4 am, for example.
Peak load pricing is not a new thing. We see it in telephone service (discounted long distance after 7 pm), cell phones (free evening and weekends), parking (outrageous prices from 8 am to 5 pm and flat rates thereafter), movies (discount matinees), public transit and a host of others. These services typically have the same marginal cost and changes in demand or demand elasticity are responsible for the change in price, a change that is required for rationing.
Electricity is a little different. Currently the two cleanest sources of electricity available on a large scale are hydro and nuclear. They also have very low marginal costs of production. When the demand for electricity exceeds the capacity of our dams and nuclear generators we must turn on the generators that use fossil fuels – largely coal and natural gas. The increase in marginal cost implies an increase in the price of electricity at peak periods, in addition to the effects of demand and elasticity changes.
The implementation of smart meters gives buyers of electricity an incentive to shift their consumption, where possible, to periods where usage and therefore prices are lower. By doing so, the buyers can reduce their total electricity bill. Spreading consumption out more evenly throughout the day also reduces the need for fossil fuel generators at peak periods. An external benefit is that shifting consumption can lead to reductions in GHG emissions.
Until we have a change in technology that allows for the inexpensive, efficient storage of electricity, smart meters appear to offer the best economic incentive to reduce power usage during peak periods.
Interesting asides:
ScottishPower has an effective “battery” at is Cruachan facility.
BC Hydro had a press release on February 18, 2010 announcing their smart meter program
BC Premier Gordon Campbell announced on September 20, 2007 that smart meters were coming to BC. See Vancouver Sun article.
The Ontario government introduced legislation on Nov 3, 2005 to start the implementation of smart meters in that province. See the CBC News article.
Peak load pricing is not a new thing. We see it in telephone service (discounted long distance after 7 pm), cell phones (free evening and weekends), parking (outrageous prices from 8 am to 5 pm and flat rates thereafter), movies (discount matinees), public transit and a host of others. These services typically have the same marginal cost and changes in demand or demand elasticity are responsible for the change in price, a change that is required for rationing.
Electricity is a little different. Currently the two cleanest sources of electricity available on a large scale are hydro and nuclear. They also have very low marginal costs of production. When the demand for electricity exceeds the capacity of our dams and nuclear generators we must turn on the generators that use fossil fuels – largely coal and natural gas. The increase in marginal cost implies an increase in the price of electricity at peak periods, in addition to the effects of demand and elasticity changes.
The implementation of smart meters gives buyers of electricity an incentive to shift their consumption, where possible, to periods where usage and therefore prices are lower. By doing so, the buyers can reduce their total electricity bill. Spreading consumption out more evenly throughout the day also reduces the need for fossil fuel generators at peak periods. An external benefit is that shifting consumption can lead to reductions in GHG emissions.
Until we have a change in technology that allows for the inexpensive, efficient storage of electricity, smart meters appear to offer the best economic incentive to reduce power usage during peak periods.
Interesting asides:
ScottishPower has an effective “battery” at is Cruachan facility.
BC Hydro had a press release on February 18, 2010 announcing their smart meter program
BC Premier Gordon Campbell announced on September 20, 2007 that smart meters were coming to BC. See Vancouver Sun article.
The Ontario government introduced legislation on Nov 3, 2005 to start the implementation of smart meters in that province. See the CBC News article.
Wednesday, May 19, 2010
The Woes of Teaching Evaluations
Competitive markets yield efficient outcomes. But efficiency requires information. In a competitive market, a store that sells bad products will go out of business, but if people do not have information about the quality of the product they are buying, the store can sell this bad product and make a profit.
Universities are in the teaching business. Once a semester, students (if present in class to do so) fill out forms which evaluate their professors and TA’s. So why not make this information public?
It could be that these student evaluations provide such bad quality of information that it is worse than no information at all. It has been argued that student evaluations are “Inaccurate, demeaning and misused”, see this survey done by Mary Gray and Barbara R. Bergmann.
It could also be that there is an incentive problem? An argument against using student evaluations all together was put forth by Curtis Eaton and Mukesh Eswaran in their paper on “Differential Grading Standards and Student Incentives”, that grading standards are not uniform across disciplines. So if students give better evaluations to easy markers, it could mean that professors have an incentive to inflate grades. Economics tells us to think about missing markets and resulting inefficiencies. The absence of official teaching evaluations creates a market for unofficial ones; most popular is ratemyprofessors.com (complete with revenue-generating ads). Ratemyprofessors.com, provides a valuable service. It is at least some way of getting information on potential professors you may encounter.
Some argue that ratemyprofessors is biased as only students who love or hate a course will contribute to the ratings. This is a professor-centric view. Ratemyprofessors is written by students for students and a typical (rational) review should be useful. For example, one of us has been rated in a course that we never taught.
The only way to prevent students from relying on websites such as ratemyprofessors is to provide alternative and better data. Maybe, if teaching evaluations were published, students would take them seriously, because they know their ratings will guide future students' choices. Of course, that better data would have to respect students' and professors' legitimate privacy concerns. But since keeping an evaluation private signals that you might have something to hide, will people choose this route? Any student-generated measure faces a specific problem, that students by definition do not have specialized knowledge of the material they are being taught.
The fundamental problem in the educational market place is information: how can you tell if your teacher is a lemon? I wish I had an answer for that one. I don't even know if public teaching evaluations would help more than they would harm.
Universities are in the teaching business. Once a semester, students (if present in class to do so) fill out forms which evaluate their professors and TA’s. So why not make this information public?
It could be that these student evaluations provide such bad quality of information that it is worse than no information at all. It has been argued that student evaluations are “Inaccurate, demeaning and misused”, see this survey done by Mary Gray and Barbara R. Bergmann.
It could also be that there is an incentive problem? An argument against using student evaluations all together was put forth by Curtis Eaton and Mukesh Eswaran in their paper on “Differential Grading Standards and Student Incentives”, that grading standards are not uniform across disciplines. So if students give better evaluations to easy markers, it could mean that professors have an incentive to inflate grades. Economics tells us to think about missing markets and resulting inefficiencies. The absence of official teaching evaluations creates a market for unofficial ones; most popular is ratemyprofessors.com (complete with revenue-generating ads). Ratemyprofessors.com, provides a valuable service. It is at least some way of getting information on potential professors you may encounter.
Some argue that ratemyprofessors is biased as only students who love or hate a course will contribute to the ratings. This is a professor-centric view. Ratemyprofessors is written by students for students and a typical (rational) review should be useful. For example, one of us has been rated in a course that we never taught.
The only way to prevent students from relying on websites such as ratemyprofessors is to provide alternative and better data. Maybe, if teaching evaluations were published, students would take them seriously, because they know their ratings will guide future students' choices. Of course, that better data would have to respect students' and professors' legitimate privacy concerns. But since keeping an evaluation private signals that you might have something to hide, will people choose this route? Any student-generated measure faces a specific problem, that students by definition do not have specialized knowledge of the material they are being taught.
The fundamental problem in the educational market place is information: how can you tell if your teacher is a lemon? I wish I had an answer for that one. I don't even know if public teaching evaluations would help more than they would harm.
Tuesday, May 18, 2010
Boring Canada now an economic star?
The current issue of the Economist is declaring Canada an "economic star", see article.
When our U.S neighbours fell into a recession, there were fears we would follow. The light at the end of the tunnel? We are nine months into recovery from our mildest and shortest downturn in recent history, while the United States has yet to declare their recession over.
The unemployment rate in Canada was 8.10 percent in April of 2010 and has been falling since last August. See Canada’s Unemployment Rate chart here.
Finance Minister Jim Flaherty, attributes our strong performance to the “boring” financial system. Banks were much more conservative in their lending than banks in America, and those who dealt with subprime loans were able to withdraw quickly. It is also reported that the volume and value of home sales in Canada are now at record highs.
During the recession the Bank of Canada cut its benchmark interest rate (to 0.25%), injected extra liquidity and bought up mortgage-backed securities. At its April policy meeting the bank withdrew its pledge not to raise rates. Analysts expect an increase in June. The government has ended tax credits for first-time house buyers and for renovations, which were granted in 2008 to stimulate demand.
There is another factor here at work- an increase in demand for exports of oil, gas, and minerals. At their low point, commodity exports from Canada were still 50% higher than in previous recessions. The energy industry is also looking good, with new investments planned for Alberta’s oil sands.
Our dollar fell as low as 77 American cents during the recession but is now back up close to parity. However, the central bank warns that a strong loonie will slow recovery and could be harmful to manufacturing exporters (car production fell by 31% in 2009).
All in all, much of our resilience stems from policy, bank regulation and sound public finances as mentioned above. We can give some credit to the Bank of Canada also.
When our U.S neighbours fell into a recession, there were fears we would follow. The light at the end of the tunnel? We are nine months into recovery from our mildest and shortest downturn in recent history, while the United States has yet to declare their recession over.
The unemployment rate in Canada was 8.10 percent in April of 2010 and has been falling since last August. See Canada’s Unemployment Rate chart here.
Finance Minister Jim Flaherty, attributes our strong performance to the “boring” financial system. Banks were much more conservative in their lending than banks in America, and those who dealt with subprime loans were able to withdraw quickly. It is also reported that the volume and value of home sales in Canada are now at record highs.
During the recession the Bank of Canada cut its benchmark interest rate (to 0.25%), injected extra liquidity and bought up mortgage-backed securities. At its April policy meeting the bank withdrew its pledge not to raise rates. Analysts expect an increase in June. The government has ended tax credits for first-time house buyers and for renovations, which were granted in 2008 to stimulate demand.
There is another factor here at work- an increase in demand for exports of oil, gas, and minerals. At their low point, commodity exports from Canada were still 50% higher than in previous recessions. The energy industry is also looking good, with new investments planned for Alberta’s oil sands.
Our dollar fell as low as 77 American cents during the recession but is now back up close to parity. However, the central bank warns that a strong loonie will slow recovery and could be harmful to manufacturing exporters (car production fell by 31% in 2009).
All in all, much of our resilience stems from policy, bank regulation and sound public finances as mentioned above. We can give some credit to the Bank of Canada also.
Thursday, May 13, 2010
More on the Parallels between Greece and the U.S.
Two articles showed up after our last blog about the similarities between the Greek crisis and the fiscal situation in the United States.
The first, from the NY Times suggests that without extensive budget cuts and increases in taxes, the US debt will reach 140% of GDP within 20 years. The blame, of course, lies with the people that have come to expect more and more government services without having to pay for them ... tax someone else. This applies to almost everyone. Thus, we elect politicians that will promise us something for nothing. We once considered running for office (we didn't because marathons were easier) but no one would vote for us. We were promising tax increases on individuals, lower taxes on corporations to stimulate growth enhancing investment and the legalization of most recreational drugs to reduce the crime and enforcement costs. Economically sound policies just don't sell to the electorate.
The second article is from Bloomberg that explains in greater detail the effect of using easy policy to monetize the debt - an option not available to Greece or the individual states like New York and California.
We also bring your attention to Professor Paul Krugman's blog where he questions the validity of the NY Times debt projections. His argument relies on a U.S. economic growth rate that may not be sustainable. The United States' biggest market for exports is Canada (20.1%). Now, we may be biased but Canada seems to be in pretty good shape. However, China, Japan, UK and Germany account for another 20% (Source: CIA Factbook). A collapse in the euro, as explained in detail in the Bloomberg article puts growth in European exports in jeopardy. Japan shouldn't expect any growth in the foreseeable future and no one is sure what China will do with respect to the yuan. Don't count on domestic spending. Increases in taxes and decreases in spending, as required to reduce the debt, using arguments from Krugman's textbook will have a contractionary effect on the domestic economy.
Professor Greg Mankiw doesn't agree with Professor Krugman. In his (best selling) textbook, a reduction in the deficit/debt may actually improve business and consumer confidence and have expansionary effects.
The first, from the NY Times suggests that without extensive budget cuts and increases in taxes, the US debt will reach 140% of GDP within 20 years. The blame, of course, lies with the people that have come to expect more and more government services without having to pay for them ... tax someone else. This applies to almost everyone. Thus, we elect politicians that will promise us something for nothing. We once considered running for office (we didn't because marathons were easier) but no one would vote for us. We were promising tax increases on individuals, lower taxes on corporations to stimulate growth enhancing investment and the legalization of most recreational drugs to reduce the crime and enforcement costs. Economically sound policies just don't sell to the electorate.
The second article is from Bloomberg that explains in greater detail the effect of using easy policy to monetize the debt - an option not available to Greece or the individual states like New York and California.
We also bring your attention to Professor Paul Krugman's blog where he questions the validity of the NY Times debt projections. His argument relies on a U.S. economic growth rate that may not be sustainable. The United States' biggest market for exports is Canada (20.1%). Now, we may be biased but Canada seems to be in pretty good shape. However, China, Japan, UK and Germany account for another 20% (Source: CIA Factbook). A collapse in the euro, as explained in detail in the Bloomberg article puts growth in European exports in jeopardy. Japan shouldn't expect any growth in the foreseeable future and no one is sure what China will do with respect to the yuan. Don't count on domestic spending. Increases in taxes and decreases in spending, as required to reduce the debt, using arguments from Krugman's textbook will have a contractionary effect on the domestic economy.
Professor Greg Mankiw doesn't agree with Professor Krugman. In his (best selling) textbook, a reduction in the deficit/debt may actually improve business and consumer confidence and have expansionary effects.
Tuesday, May 11, 2010
Australia, New York, China, Germany ... and of course ... more Greece.
Some days we get up and can't find any articles that inspire us. Today is not one of those days, for the world has gone crazy ... almost as crazy as us.
First, we bring your attention to an article in the Globe and Mail that comments on the $1 trillion bailout for the euro. Apparently, a day after markets went wild with euphoria, traders woke up and thought about the implications. Seems the deficit spending problem has not been cured and the threat to the euro has only been temporarily abated. Wish someone had said something earlier ... wait ... we did!!
Meanwhile, an article in the Telegraph suggests that German voters are upset with Chancellor Angela Merkel for saddling them with Greece's inability to restrain themselves. The German voters were so upset that they trounced Ms Merkel's Christian Democrat Party in regional elections over the weekend striping her of her majority. Speculation in Der Spiegel magazine is that she will soon lose her role as party leader. Germany will have to forego planned tax cuts to fund their share of the bailout. The Greeks are happy ... the Germans, not so much.
And just so you don't start to think that this problem is restricted to Europe, we draw your attention to an article in the NY Post. Seems that the state government is unable to balance their budget and the state workers' union is unwilling to accept pay freezes and are now protesting the planned furloughs decreed by the Democratic governor of the state. How do you spell "New York" in Greek? There is an underlying similarity here, neither Greece nor the State of New York has access to monetary policy as a stimulative tool. If California wasn't in worse shape, maybe they could bail out New York.
An interesting aside to the debt problem. As we mentioned yesterday, the United States is in a different position from the European countries. China has been using exchange rate policy to stimulate their economy. This occurs when the exchange rate is pegged at a rate below the market equilibrium. The yuan (renminbi)is undervalued in comparison to the US dollar. This makes Chinese exports cheaper and stimulates the domestic economy. China's trade surplus must be balanced by a Capital account surplus - US dollars flowing into China. To maintain the low exchange rate, the Chinese central bank must sell yuan into the market, increasing liquidity and the money supply. This may be one cause of the current housing boom. However, increasing the money supply in excess of the economic growth rate is sure to cause inflation. An article in the China Post indicates that the government may not be able to meet the 3% target this year. Monetary policy only works if it's credible. Setting an inflation target and missing it reduces the credibility of the central bank and increases expected inflation making it more difficult to control future inflation.
And while we're on that side of the world, we are reserving judgement on Australia's plan to impose a "Resource Super Profits Tax" on big miners operating in that country. See the Reuters article. We applaud the effort to avoid budget deficits but have to wait and see if Prime Minister Kevin Rudd and his colleagues in the Labour Party have done their homework. Mining giants BHP Billiton, Rio Tinto and Xstrata are all opposed to the tax ... no surprise there, their after tax profits will fall. Whether or not the tax has an effect on investment in that coountry will depend on the cost structure of the firms and the investment opportunities that exist in other countries. If the Net Present Value of a project was positive before the proportional tax, it should also be positive after the tax. Unless the companies are capital constrained, those projects should still go ahead.
Stay tuned.
First, we bring your attention to an article in the Globe and Mail that comments on the $1 trillion bailout for the euro. Apparently, a day after markets went wild with euphoria, traders woke up and thought about the implications. Seems the deficit spending problem has not been cured and the threat to the euro has only been temporarily abated. Wish someone had said something earlier ... wait ... we did!!
Meanwhile, an article in the Telegraph suggests that German voters are upset with Chancellor Angela Merkel for saddling them with Greece's inability to restrain themselves. The German voters were so upset that they trounced Ms Merkel's Christian Democrat Party in regional elections over the weekend striping her of her majority. Speculation in Der Spiegel magazine is that she will soon lose her role as party leader. Germany will have to forego planned tax cuts to fund their share of the bailout. The Greeks are happy ... the Germans, not so much.
And just so you don't start to think that this problem is restricted to Europe, we draw your attention to an article in the NY Post. Seems that the state government is unable to balance their budget and the state workers' union is unwilling to accept pay freezes and are now protesting the planned furloughs decreed by the Democratic governor of the state. How do you spell "New York" in Greek? There is an underlying similarity here, neither Greece nor the State of New York has access to monetary policy as a stimulative tool. If California wasn't in worse shape, maybe they could bail out New York.
An interesting aside to the debt problem. As we mentioned yesterday, the United States is in a different position from the European countries. China has been using exchange rate policy to stimulate their economy. This occurs when the exchange rate is pegged at a rate below the market equilibrium. The yuan (renminbi)is undervalued in comparison to the US dollar. This makes Chinese exports cheaper and stimulates the domestic economy. China's trade surplus must be balanced by a Capital account surplus - US dollars flowing into China. To maintain the low exchange rate, the Chinese central bank must sell yuan into the market, increasing liquidity and the money supply. This may be one cause of the current housing boom. However, increasing the money supply in excess of the economic growth rate is sure to cause inflation. An article in the China Post indicates that the government may not be able to meet the 3% target this year. Monetary policy only works if it's credible. Setting an inflation target and missing it reduces the credibility of the central bank and increases expected inflation making it more difficult to control future inflation.
And while we're on that side of the world, we are reserving judgement on Australia's plan to impose a "Resource Super Profits Tax" on big miners operating in that country. See the Reuters article. We applaud the effort to avoid budget deficits but have to wait and see if Prime Minister Kevin Rudd and his colleagues in the Labour Party have done their homework. Mining giants BHP Billiton, Rio Tinto and Xstrata are all opposed to the tax ... no surprise there, their after tax profits will fall. Whether or not the tax has an effect on investment in that coountry will depend on the cost structure of the firms and the investment opportunities that exist in other countries. If the Net Present Value of a project was positive before the proportional tax, it should also be positive after the tax. Unless the companies are capital constrained, those projects should still go ahead.
Stay tuned.
When the Fox preaches take care of your geese.
The Township of Langley has been receiving a lot of press lately related to the fill-dumping going on in their jurisdiction. Fill-dumping, or “fill farming” as it is now being referred to by Mayor Rick Green, is a practice by which farmers can bring in truckloads of fill and use it to level their grounds. It is legal as long as it improves the land. However, it is proving to be quite lucrative for Lower Mainland developers and contractors who, during a building boom, see the farms as prime dumping grounds for their fill, see the Province article.
These developers are now buying farms specifically for this purpose as agricultural land is cheaper than other properties.
So they legally apply for fill-dumping permits through the Langley Township claiming land improvement, which cannot legally be turned down by the Township and forwarded to the Agricultural Land Commission, who then approves or denies the application based only on its farm-improvement criteria. Once a permit is issued, it is back in the hands of the Township for enforcement.
The damage is in the trucks wear and tear on the roads, noise and dust for neighbours (or foxes, but Langley has lots of wild animals), not to mention the environmental damage on wells and streams due to fill runoff and damaged farmland.
Councillor Charlie Fox, who coincidentally lives near to a fill-site himself, has been quoted saying:
"We have to make sure land filling is done in the best interests of agriculture, not in the best interests of lining some-one's pockets."
Not that we see a moral hazard problem here at all...
Langley times further reports that at a council meeting last week, Fox “recognized that staff have not always reacted to neighbours’ concerns or upheld the Township’s soil bylaw.”
“We know staff are being questioned for their decisions or lack thereof,” Fox said.
“But to be fair, there is only one person remaining in soils. The main staff member has retired and two soil technologists are to be hired on. One might question whether that staff member was a duly sworn peace officer as prescribed by the governing provincial legislation and thus capable of enforcing the bylaw in question.
But wait, isn’t it the Agricultural Land Commission that has power over approving fill sites, not the Township? Though the Township is required to give a permit for fill but has the power to stop work if the proponent is in contravention of the amount of fill the permit allows, this proves to be more costly than one would first suspect after reading the articles. In order to enforce a $750 fine to these “fill-farmers” the Township has to take it all the way to the B.C. Supreme Court, which would cost them something along the lines of oh say $10,000.
Are we surprised that if it is possible to make a larger profit by “fill-farming” than actual farming, and that this negative externality is not priced properly or enforceable, that people are going ahead and doing it? Even abusing the permits by adding in a few extra truckloads? At $50-$80 per truck load of fill with permits allowing for thousands of truckloads we are taking quite large gross revenue.
These developers are now buying farms specifically for this purpose as agricultural land is cheaper than other properties.
So they legally apply for fill-dumping permits through the Langley Township claiming land improvement, which cannot legally be turned down by the Township and forwarded to the Agricultural Land Commission, who then approves or denies the application based only on its farm-improvement criteria. Once a permit is issued, it is back in the hands of the Township for enforcement.
The damage is in the trucks wear and tear on the roads, noise and dust for neighbours (or foxes, but Langley has lots of wild animals), not to mention the environmental damage on wells and streams due to fill runoff and damaged farmland.
Councillor Charlie Fox, who coincidentally lives near to a fill-site himself, has been quoted saying:
"We have to make sure land filling is done in the best interests of agriculture, not in the best interests of lining some-one's pockets."
Not that we see a moral hazard problem here at all...
Langley times further reports that at a council meeting last week, Fox “recognized that staff have not always reacted to neighbours’ concerns or upheld the Township’s soil bylaw.”
“We know staff are being questioned for their decisions or lack thereof,” Fox said.
“But to be fair, there is only one person remaining in soils. The main staff member has retired and two soil technologists are to be hired on. One might question whether that staff member was a duly sworn peace officer as prescribed by the governing provincial legislation and thus capable of enforcing the bylaw in question.
But wait, isn’t it the Agricultural Land Commission that has power over approving fill sites, not the Township? Though the Township is required to give a permit for fill but has the power to stop work if the proponent is in contravention of the amount of fill the permit allows, this proves to be more costly than one would first suspect after reading the articles. In order to enforce a $750 fine to these “fill-farmers” the Township has to take it all the way to the B.C. Supreme Court, which would cost them something along the lines of oh say $10,000.
Are we surprised that if it is possible to make a larger profit by “fill-farming” than actual farming, and that this negative externality is not priced properly or enforceable, that people are going ahead and doing it? Even abusing the permits by adding in a few extra truckloads? At $50-$80 per truck load of fill with permits allowing for thousands of truckloads we are taking quite large gross revenue.
Monday, May 10, 2010
Moral hazard and sovereign debt
So, once again, we (the world's taxpayers) have bailed out the banks that decided it was a good idea to continue lending to a country (Greece) that had no hope of paying back the loans. Be clear that these loans are not bailing out Greece, just reducing the interest rate that the banks are charging to lend to them.
If this sounds a lot like the bailout of the banks when they decided to lend mortgage funds to people that had no hope of paying back those mortgages, it is.
At some point, governments of the world must realize that every dollar they borrow must be repaid with interest. For taxpayers, that means that deficit spending now means higher taxes in the future - not a reduction in government spending because no politician is willing to do that. Witness the deadly riots in Greece, the hung parliament in England and the soap opera that is the American government. There is one exception to this rule: those countries with sovereign currencies can choose to pay off their debts by printing money. This is true for Britain, Japan, the US and Canada. Unfortunately, for the countries that signed on to the euro, this is not an option. A country that chooses to monetize their debt faces a future of higher inflation rates and a greatly reduced effectiveness of monetary policy.
The core of the current world economies can be traced back to the misguided belief that expansionary Keynesian fiscal policy can actually work. The evidence suggests otherwise. Greece's massive debt has produced a GDP growth rate of -2%. Spain, Portugal and France are not doing well either. The US is in a unique position - China's refusal to revalue the yuan has, in part, fuelled the massive trade imbalance with the US. Only the US has enough outstanding sovereign debt for the Chinese to purchase. US fiscal policy is being funded by China.
The recent bailout of the banks creates a moral hazard problem. Governments around the world know that they can continue to borrow and the big banks will continue to lend to them because the big governments will continue to bail out the banks. What incentive then, do the PIIGS have to control their deficits?
Today's 10-year bond yields tell the story:
Greece down 467 basis points (one basis point is 1/100 of 1%)
Italy down 30 basis points
Spain down 51 basis points
Mexico down 16 basis points
Germany up 16 basis points
Switzerland up 8 basis points
UK up 9 basis points
US up 13 basis points
Canada up 7 basis points
You get the point. You have just witnessed a massive wealth transfer from taxpayers in responsible countries to taxpayers in irresponsible countries.
Don't say you weren't forwarned.
If this sounds a lot like the bailout of the banks when they decided to lend mortgage funds to people that had no hope of paying back those mortgages, it is.
At some point, governments of the world must realize that every dollar they borrow must be repaid with interest. For taxpayers, that means that deficit spending now means higher taxes in the future - not a reduction in government spending because no politician is willing to do that. Witness the deadly riots in Greece, the hung parliament in England and the soap opera that is the American government. There is one exception to this rule: those countries with sovereign currencies can choose to pay off their debts by printing money. This is true for Britain, Japan, the US and Canada. Unfortunately, for the countries that signed on to the euro, this is not an option. A country that chooses to monetize their debt faces a future of higher inflation rates and a greatly reduced effectiveness of monetary policy.
The core of the current world economies can be traced back to the misguided belief that expansionary Keynesian fiscal policy can actually work. The evidence suggests otherwise. Greece's massive debt has produced a GDP growth rate of -2%. Spain, Portugal and France are not doing well either. The US is in a unique position - China's refusal to revalue the yuan has, in part, fuelled the massive trade imbalance with the US. Only the US has enough outstanding sovereign debt for the Chinese to purchase. US fiscal policy is being funded by China.
The recent bailout of the banks creates a moral hazard problem. Governments around the world know that they can continue to borrow and the big banks will continue to lend to them because the big governments will continue to bail out the banks. What incentive then, do the PIIGS have to control their deficits?
Today's 10-year bond yields tell the story:
Greece down 467 basis points (one basis point is 1/100 of 1%)
Italy down 30 basis points
Spain down 51 basis points
Mexico down 16 basis points
Germany up 16 basis points
Switzerland up 8 basis points
UK up 9 basis points
US up 13 basis points
Canada up 7 basis points
You get the point. You have just witnessed a massive wealth transfer from taxpayers in responsible countries to taxpayers in irresponsible countries.
Don't say you weren't forwarned.
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