:LPE:

Some folks ahve said it for ages, but They said it about a year ago, Their soon-to-retire bankers are saying it, and historians not normally persuaded have agreed, and their erstwhile leader Iggy has finally said what no other electable government dare say: the time has come to raise government revenues through higher (income) taxes (well, they often say consumption taxes too). Link.

The economics of it (pretty sound), the politics of it are amusing, perhaps ironic. After fanning the flames of tax rage for three decades, and finally rising up and forming government, the elites have turned on this policy, at least in the very short term, while we get public balance sheets in order and build a consensus about long-term dissolution of public programs and assets to permit the again long-term reduction in government revenues. So, no illusions about the big picture, but living in the moment, just for a moment, we have a broad consensus of business elites (the “C-Suite” no less) asking for versions of revenue-generation by governments. Terry Corcoran must be bursting a seam.

Assuming the feds wanted to do it, how would they? Do we now have to pour sand on the tax rage? Or just do it under the radar (a la Clinton in 1993)? And, of course, income or consumption, which system? The answers are pretty obvious to a far assessment, but they’re riddled with “special interests”. And to put it all in a broader context: is the current boomer generation, at the top of its salary scale, willing to part with 50% of its legacy in an inheritance tax, now that they have been educated and their health protected by state institutions for 45 to 65 years? Are they willing to part with a greater share of pre-tax income to ensure the same institutions exist for their grand-kids? My guess is not. They’re partial to parsimonious disposition that we all have to tighten belts, which is an interesting psychological position: it is the equivalent of the parent saying, before some kind of corporal punishment, “this is going to hurt me more than you”. Spanking is sadly still legal in this country, but at least the C-suite disapproves, if only for a short time.

This is probably my favourite leveraged synergy, value-added, convergance premium, blah blah of the year. FT reports that the Association of British Insurers suggests that advisor fees in corporate restructurings are sufficiently high as to reduce overall value from the deals, and are, in their phrase, akin to deadwight losses. Link.

An unlovely phrase, but a useful one. This is random and almost anecdotal, but it reminds us that advisors have a massive stake (conflict?) in the churning of transactions, which makes about as much sense as many of the long-term metrics of deal value. The last time I took a tour through the secondary literature, European authors had gone farther than their North American counter-parts in conducting longitudinal studies of M&A activity, and used a wider variety of markers, including a brooder array of corporate stakeholders (including, for example, advisors, labour inputs, consumers, etc. in various ways). The upshot as of a few years ago was that share price didn’t support the “unlocking value” hypothesis consistently, and that we had to look behind share price or even valuation to understand any value in the deals: other hypotheses included “blocking” deals to preserve market position (e.g., opportunity cost of not doing the deal was too high, although this borders on anti-competitive behaviour), culture clashes in workplaces that were not factored into the “converged synergies” and thus resulted in bad deals (typically for the purchasor), and overall market hype about deals (BCE). Of course, fees to advisors is another wonderful factor, as well as management cash-outs, and even, as the NYT discussed last year, the need for fund owners to shift stuff around in their portfolios to meet medium and short-term transaction targets entirely unrelated to the economics of a deal. Or, if you prefer the more speculative (paranoid?) end of the spectrum, the trading of ownership rights among elites in some rarified game.

There is a sort of debate developing, it seems, among experts in retirement income systems. Last December, Jack Mintz (U Calgary) and Bob Baldwin (Informetrica) both produced long reports on the adequacy of retirement income in Canada, and broadly speaking both concluded people are saving enough to meet their income targets in retirement — noting that those income targets are usually between 50% and 70% of their pre-retirement income. They noted that those with low incomes (say, less than 30k per year) usually get public program support to replace lost wage income, and those with high incomes have other ways to save. The middle income group (say, 30-130k) are saving, but may not have enough to hit a 70% replacement rate in retirement, they predict, although they may not need 70%, says Mintz, if they just sell their house. (That’s right, the Mintz research counts all household assets as contributing toward retirement income, icluding house equity and durables. This is a bit of a fantasy, as the reverse mortgage market is even thinner and more expensive than the annuity market.)

Along comes David Dodge today, Link, certainly no fan of defined benefit plans, but broadly familiar with financial matters, and he says Canadians are not saving nearly enough for retirement. His study (for the CD Howe Institute) suggests that the requires savings rate is 15-21% of earnings, in order to hit 70% replacement rate. Most people do not save that much each year, except in some large public sector pension plans. These figures are more or less similar to other research on these issues by Keith Ambachtsheer, who in his latest book (which is only a repackaging of his monthly newsletters) ruminates from time to time about 20-25% of earnings being the required rate of savings necessary to invest in an individual account (RRSP) to esnure, given market ups and downs, that you have your target 70% of income in retirement at 65.

Some preliminary thoughts.

Mintz (who relies on a study by Horner) is making some aggresive assumptions about what financial resources are fungible in retirement. Home equity may be converted into income via a reverse mortgage, but they are very expensive. That is inefficient. If this became a wide-spread source of income, query effects on housing prices (like any other assets that must be sold in quantity to pay for cash flows). Recent work in the US and UK examines the role of home equity in retirement income and comes to similar conclusions. We might also note that home equity has steadily declined over the past 30 years, which is to say, it is becoming less able to provide such income. (I have not even mentioned renters, who are left out in the cold.) All this emphasis on home equity to replace pensions is just shifting the problem (not revealing a solution) and puts much more focus on the tax treatment of saving for retirement via your home: should interest be deductible? Are protections of capital gains right or sufficient to incent enough saving? Should homes therefore be subject to similar constraints on alienation? And so-forth.

Dodge manages to turn his study into a pitch for providing greater tax relief to high income people. Fine, as long as it ends up ensuring that middle and low income people are aided by policy reform that improves the adequacy of their retirement income. Raising RRSP room does not do that. The real crux of the matter is that it is very diffuclt to get people to save when aggregate wages have not risen in real terms for about 25 years. Their employers always face the same cost problems as well — few would easily agree to raising the wage package 5, 10 or 15% to ensure adequate retirement savings. Many employers would prefer to exit the pension provision altogether — and the system is in some kind of decline that way. Making a voluntary or opt-out plan is the current vogue in “choice architecture”, relying on the behaviour laziness of people to fail to object to paying an extra 10 or 15% in pension contributions. This may work, I don’t know (studies estimate up to 70% of people fail to opt out even if they want to), so it may increase the savings rate. In the old days, we just made things mandatory and people adjusted, but we’re of a more libertarian bent today.

Is there a terminal point on this horizon? Doubtful, but the debate about adequacy and coverage will hopefully shed some light on better policy reform, sooner.

In the past when the value of the loonie has increased, we have heard that this harms the Canadian economy as a whole because exports become relatively more expensive for others (but on the other hand, imports cheaper). For a traditional analysis, see today’s Globe.

We’re told that this time it is different. For this analysis, see also today’s Globe. This analysis says that even with a strong dollar value relative to other countries, exports are increasing.

A couple of qualifications. The second article reports on a monthly Statstics Canada report yesterday that measures overall manufacturing sales and inventories. This aggregates domestic and export demand, which according to the article represent about 50% each. It is broken down by sector. The sectors with the biggest increases were: auto sector and petroleum. Both feature significant exports to the U.S., true, but the auto sector could not have had a worse year last year, so a rebound should be pout in context (and as a sign of strength, it should be but in context).

Second, the December statistics were revised, and the January statistics (reported on) are preliminary, and subject to revision. This is relevant to note.

Third, the value of the loonie was relatively flat between September 2009 and January 2010, only beginning a rapid rise after January 2010. In other words, the “loonie effect” is not yet fully worked through manufacturing prices.

Fourth, as the article points out (and contrary to the headline), some manufacturers are “adapting” by not hiring new workers as a result of the rise, but squeezing more capacity (hours worked) out of existing workers. Hence, a relatively tepid effect on unemployment and as other articles in today’s Globe point out, the duration of unemployment is lengthening in Canada (as it is the U.S.).

In short, no realistic basis for the headline or the conclusion that the traditional analysis on the imapct of the loonie should be abandoned. Eventually, it will affect export sectors and it will continue to make it difficult for the BoC to time interest rate increases.

Link.

CBC has a morning radio business affairs reporter, Michael Hlinka. He provides one explanation for recent Canadian bank profits: a domestic carry trade using (quasi) public money. Thast is, they borrow from the BoC at very low rates, as a part of the BoCs policy for injecting liquidity into the credit system, and turn around and use the money to buy treasuries (gov’t bonds) at low but not as low a rate of return. The difference is pure profit. So far, so good.

But Hlinka also says there is no question low borrowing rates were passed on to consumers and business borrowers. Maybe, but this is too simple. Mortgage rates are now low (but not as low as the borrowing rate of the BoC), but lending rates took a good long time to lower after the BoC dropped its rates. Last year about this time, the BoC and the Minister of Finance had to publicly admonish private lenders for *not* providing more affordable lending. So, the banks made sure to pad their balance sheets before anything got passed along.

I’m not familiar with other consumer lending rates or business lending rates, but query whether there has been a deflation in the overall price of non-mortgage lending. I wonder. Hlinka may be right, but I’d be interested in knowing those spreads.

The same columnist appears to have partaken of the cool aid, however, in an earlier column on national debts and deficits. He examines Greece and calls it a harbinger of things to come, or an indication of the plight of all industrialized countries. Ummm, maybe.

But a little context might help. First, the EU target of 3.0%. This might be a sane target for a prosperous time, but it is an insane target after the worst economic recession and financial collapse of 75 years. No-one is serious about those targets (set, what, 20 years ago?) in the past 18 months while they tried to stave off a much worse recession. So, the target is a meaningless metric to measure current performance against. For example, even current debt:GDP ratios of 12% are lower by almost 50% than historical post-war highs (I’m not sure about Greece, but here and in the UK and US). So, we’ve had such bills to pay in the past, and parenthetically, they preceeded the greatest expansion of our economy ever seen.

Second, Greece’s problems are in part because of the EU and Euro: it doesn’t have a currency that would float to reflect current economic conditions in Greece, which, as we know in Canada, is important to the value of our imports/exports. When the dollar rises, our export sectors are less competitive. Greece lacks a clear adjustment mechanism as such.

Third, Greece still has a very large public sector, something which it appears will now change with some form of what used to be called “structural adjustment”. The Canadian and U.S. and U.K. public sectors are all a far smaller proportion of the economy (although they will also be restructured, it seems, next year).

Fourth, projections of future indebtedness should always be considered as against future production, and the latter is less well acknowledged in stories on public debts and deficits. Hlinka does measure the debt as a fraction of GDP, which is the broadly accepted way to do it (he also speaks of per capital level of debt, which is a little scare-mongering and somewhat misleading).

Lastly, an important element in any story about who and how we should address public debts is to ask how they were created: in this case, the causes of these debts were, variously, tax cuts, financial sector bailout, program spending in two forms, business lending or investment and direct transfers to individuals (e.g., EI enhancements). It would be useful to place a magnitude on each of these sources of the debt and deficit, which would explain a bit abouty how we got here and suggest, perhaps, equitable ways to address the accumulated debt.

First, we had a recovery of bank and near-bank balance sheets, in no small part aided by public and near-public lending to them.

Then, we have very recently seen the revival, in fits and starts, of the non-plain-vanilla security issues, such as securitized Greek debt, some more exotic corporate paper: Link.

Then, we get a de-globalization or perhaps protectionist version of bailout assistance, such as barring Wall St banks from running books on EU soverign debt issues. Link. For an interesting twist on the same themes, the view that finance is operating “offshore” and should be paying more insurance “onshore” to ensure the risks are adequately spread and public money is not required to solve the problem again. (I wonder whether the City is onshore or offshore here, but the main point is fine, as Icelanders and probably a lot of other Joe Coffees resent subsidizing large financial sector bonuses.) Link.

Lastly, we have a new dimension in the post-econoclypse vision of capital markets: everyone wants to reinflate the credit markets somehow, but the EU has a rather more governed version than the Obama administration: Link, Link, Link.

(It is difficult to tell who is pushing who around in the U.S. — the government there makes very weak noises about tax and regulation, and then aggresively defends its presence in a global market. Geither, who was apparently turned down from jobs at GS twice, is going to bat for private equity funds and hedge funds. Errrrr ….Link.)

What so surmise? The use of debt by non-financials is coming back, as there does not seem to be an adequate substitute (say, use of retained earnings), the use of public debt is going to have to continue for some time, there are no signs of real reinvestment in any significant degree outside that led by public initiatives (there are no Tenessee Valley Authorities being built or New Deal era job creation programs of any scope, yet), and there are two discernable flavours of regulatory chocolate: those with disclosure rules for hedge funds and private equity groups, and those without. (OK, we might also see some strengthening of reserve requirements and — gasp — some proposals to separate commercial and investment banking, but the latter does not appear to be seriously contemplated in the U.S., although the Fed might have its role as a consumer protector baked into express words in its mandate. But don’t hold your breath.)

About a year ago the Certified Chartered Accountants of Canada performed a useful public service and put together a series of metrics measuring household debt and the ability to pay it in Canada. In large part the data showed that credit — particularly consumer credit, but to some degree mortgage credit — had been used to maintain consumption in place of rising wages. In other words, we borrow to pay for what we cannot afford on income alone. This was and still is a relevant inquiry, as borrowing costs are predicted to rise this year, and wages, overall, are not. In January, Mark Carney noted the same problem, after it got dismissed by bank economists like Benjamin Tal last December (Tal maintains that wage increases offset rising borrowing costs, although historical evidence does not support this).

Here is the Carney chart that summarizes the issue today:

sp161209_chart5

And here a few more relevant metrics from the CCA report, based on StatCan CANSIM tables, the last observation being usually Q4 2008, so missing the large housing boom on 2009, which it seems may create a higher level of debt:asset and mortgage liability than these charts protray.

First, a similar standard Stat Can measure of household debt in aggregate and per capita.

The proportion od debt to income, assets and net worth.

Where that debt is allocated…

The proportion of debt to consumables…

Average incomes, salaried and hourly over time…

Per capital incomes (note the relatively flat line over 30 years)…

and finally, savings rate.

The recent spate of bank profit announcements has confirmed that the sector — in Canada anyway — is well out of the recessionary woods. Link. The related spate of bonus announcements confirms that we have collectively turned a blind eye to the role of financial sector compensation in the two most recent boom-bust cycles. There is no significant prospect of stricter financial sector regulation in North America or the taxation/disincentive to excessive executive pay; indeed, no real appetite for discouraging opaque risk transfer at all: Link.

You could be forgiven for thinking that everyone just wants to reverse the linear passage of time and return to 2006.

David Rosenberg properly identifies the consensus on economic reporting as over-stated and probably wrong (he calls it “hilarious”), Link.

It is relevant to note again and again, because the GlobePost ecoreporters seem incapcable of internalizing the point: we are told the prmiary if not sole source of demand in the North American economy right now is public spending and consumer spending. The former is about to be wratched back (but not ’till next year, we think) and the latter is considered unsustainable because it is expanding only through debt. Job creation and wage increases are important to provide a source of demand that isn’t personal debt, which, when interest rates rise, will be a problem and reduce income available to spend on other things.

True, private sector investment in actually making things would help stoke domestic demand. So far, little sign of that (decreased 17% by some measures last year), and who knows where it will be made if it is made. A related question (perhaps problem) is the role of the financial sector. It is already a significant proportion of the overall economy relative to its traditional size and role, and as I’ve discussed elsewhere, even non-financial firms have “financialized” to some exent. Financialization produces something — mainly service sector jobs and “outsized returns” for the very top of that sector — but it isn’t clear to me yet, anyway, what that sector will do for overall output and creation of demand.

We are about a year into “green shoots” now, and while stock indices appear to have recovered somewhat, broader indicators of well-being are less, well, green.

We have heard a couple of times about how job losses slowed in the end of 2009, and the rate of unemployment crept down very slightly in December to about 8.3%. We are told that “economists are expecting” about 18,000 jobs to be added last month, in a report to be released Friday. Link. None of this is all that inspiring.

Some context: the labour force in Canada is about 18.5M persons, and has been growing at about 1.0% per year. So, just to keep pace with normal growth, we need to add 185,000 jobs per year. Adding 18,000 in a month is treading water. (All these are very rough estimates, and employment numbers are always subject to significant revision.)

The 8.3% unemployment rate is down very slightly in January, but that is still 3.0% higher than 2007, the last pre-bust year, and and many have observed, those with employment are still 280,000 jobs lower than that period.

The types of employment matter too: private sector shed a lot more employees than the public sector, and job growth has primarily been in part-time or self-employed jobs, both of which pay less, have fewer benefits and are more temporary than other employment.

All in all, a bleak picture.