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To exit or not to exit; that is the question

There is a fascinating debate raging amongst some of the best known economists.  The debate is specific to the UK economy but when you note the number of Americans involved you can rest assured this is equally applicable to US.

The debate began with the case for belt tightening from 20 economists:

UK economy cries out for credible rescue plan | The Times

IT IS now clear that the UK economy entered the recession with a large structural budget deficit. As a result the UK’s budget deficit is now the largest in our peacetime history and among the largest in the developed world.

In these circumstances a credible medium-term fiscal consolidation plan would make a sustainable recovery more likely.

In the absence of a credible plan, there is a risk that a loss of confidence in the UK’s economic policy framework will contribute to higher long-term interest rates and/or currency instability, which could undermine the recovery.

Followed by the case for restoration of growth before belt tightening from 60 economists:

Letter: First priority must be to restore robust growth | Financial Times

Sir, In their letter to The Sunday Times of February 14, Professor Tim Besley and 19 co-signatories called for an accelerated programme of fiscal consolidation. We believe they are wrong.

They seek to frighten us with the present level of the deficit but mention neither the automatic reduction that will be achieved as and when growth is resumed nor the effects of growth on investor confidence. How do the letter’s signatories imagine foreign creditors will react if implementing fierce spending cuts tips the economy back into recession? To ask – as they do – for independent appraisal of fiscal policy forecasts is sensible. But for the good of the British people – and for fiscal sustainability – the first priority must be to restore robust economic growth. The wealth of the nation lies in what its citizens can produce.

Relevance to Bankwatch:

The 3 to 1 relationship of economists for government spending vs planned reductions in government spending certainly proves that most economists are on the liberal side of continuation of government spending.

My own take is in favour of the group of 20.  When I read the group of 60 case it is centred on the world automatically becoming better when growth kicks in, and the world returns to normal.  This reeks of an ostrich head in the sand view of the world.  What on earth would make them think “automatic reduction that will be achieved as and when growth is resumed “.  There are so many flaws in that view.  For starters, the rapid aging that follows as night follow day when the baby boomer wave hits the old folks home, leaving a much smaller group  to provide tax revenue is a double whammy of lower revenue/ higher costs.

When we read the cases carefully, the 20 group are really saying that what is needed is a plan … a plan that lays out a better approach going forward over the next 5 – 10 years that is based on reality, and that will reassure currency and financial markets.  There is no historic reference that suggests anything positive from continued government spending and debt increases.  Only bad things come from that.

Written by Colin Henderson

February 20, 2010 at 23:32

Posted in economy

Two views of Canadian economy – the external view is flawed

Consider these headlines about Canada, both published this week.

First the world view of Canada, reaffirmed at Davos.

What Toronto can teach New York and London |

That’s where Canada comes in. It is a real-world, real-time example of a banking system in a medium-sized, advanced capitalist economy that worked. Understanding why the Canadian system survived could be a key to making the rest of the west equally robust.

Next a Canadian view, that says Canada is a bubble waiting to burst, that is not widely shared other than by yours truly.

Awash in a sea of Debt | Macleans Feb 8th, 2010 (partially published on Roseth)

It seems we have learned nothing from the American debt crisis; and here in Ontario, we have forgotten the housing collapse of the early 1980’s, when house prices dropped as much as 40 % and did not recover their old values until after the turn of the century. Speculation was rife; people kept moving up, sometimes changing homes every one or two years; speculators were “flipping” homes, and ordinary people were buying forward several months and expecting their old home to appreciate before putting it up for sale. It worked for a while, but then the market turned, and some people who had committed to a new home and waiting to sell their own at higher prices had to sell much lower and ending up with a new house but a much larger mortgage. Some seniors, selling their old, large home and hoping to move into a new, smaller home, mortgage free, ended up with a smaller home with a large mortgage. Quit claims were rampant.

Now, here we go again

For the rest of the world what is happening in Canada is that home prices rose through the recession, and continue to rise.  Extraordinarily low interest rates are incenting people to borrow against equity or purchase a more expensive home than they might otherwise. The reset point for Canada will be when interest rates begin to rise.

Analysts from Bank of Canada conducted an analysis of Canadian debt from a historical perspective to 2005 recently.


In a nutshell Canadian debt was significant amongst certain groups as early as 2005.  More recently Bank of Canada conducted a sensitivity analysis that  noted risk associated with defaults if Canadian interest rates rise to the 4 – 5% range, and that would precipitate significant defaults and loss of capital at Canadian Banks.

The most telling statement in the Macleans piece is this is that ‘you never see a crisis coming’.  As recently as 2009 Scotiabank published a piece entitled “Canada’s Mortgage Market is not like the US”.  I believe they are wrong.  Time for some economists to read “This Time is Different – Eight Centuries of Financial Folly”.  As you can imagine the conclusion of the book, is that it is never different.

Written by Colin Henderson

January 30, 2010 at 14:37

Posted in economy

The impact of global fiscal stimulus is good for Canada | Bank of Canada

Canada has been receiving kudos for a job well done throughout the crisis of the lest 2 years.  This analysis from Bank of Canada has a telling paragraph (highlighted) that suggests there are good classic economic reasons for Canada being where it is, and over-confidence would be a bad idea.

The Power of Many:  Assessing the impact of Global Fiscal Stimulus | Bank of Canada

Table 4 shows that, on a regional basis, the United States, as a large and relatively less open region,
benefits the least from a global stimulus. Moreover, the impact of different measures depends on its
trade patterns. The United States is a net exporter of investment goods and commodities other than oil, but a net importer of consumption goods and oil. The United States therefore benefits more from a global stimulus when global demand is slanted towards its comparative advantage in trade (e.g.,
investment goods). Japan also has a relatively closed economy, but its trade patterns are somewhat
different: it is a large net exporter of consumption and investment goods, and an importer of oil and
commodity goods.

In contrast, Canada is a small open economy and a net importer of investment and consumption goods, but a net exporter of oil and commodities. As such, it profits greatly from the global stimulus (Table 4), the multipliers being twice as large as in the case of an isolated stimulus, owing in part to a substantial improvement in its terms of trade derived from the increase in oil and commodity prices. For similar reasons, the commodity-exporting region also benefits from a global stimulus.

Emerging Asia is highly open to trade, a net importer of oil and commodities, and a large net exporter of consumption goods (Table 4). Thus, it experiences contradictory forces to its terms of trade under a global stimulus. Moreover, the presence of a large contingent of non-Ricardian agents results in almost no change in private consumption and investment under a fiscal stimulus, either local or global. The remaining countries benefit less from a global stimulus, owing to the large size of this region (39 per cent of global GDP).

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Written by Colin Henderson

January 27, 2010 at 18:32

Posted in Canada, economy

Thoughts on ‘The End Game’ and ‘This Time is Different’

My weekly newsletter from John Maudlin, cross posted here on The Business Insider is valuable to me in setting context for the longer view in the economy for North America, Europe and Japan.  This week is no exception.  Having spent 2009 reviewing inflation, and deflation prospects, he has now turned to thinking about what the economy will look like in the mid term future – The End Game.

Over the next several months, we are going to start to explore various aspects of the end game. Whither Japan? Are they actually, as I think, a bug in search of a windshield? What does that mean for the world? How safe is the euro? Everyone over here seems to think Germany will bail out Greece. A breakup seems unthinkable to the people I’ve been talking to (so far). But what about Spain? Italy? Can you spell moral hazard?

The theme he is focused on is excessive debt and the results of deleveraging.  He points to important research on the topic and useful books are summarised by him and other contributor colleagues of his.  [Incidentally for my take on the impact on banks, see my small trilogy “The Great Unwinding” from last year.]

We can forget about new debt being sought to solve the leverage problem because new debt increases leverage.  This may offer context for governments complaining about banks restricting credit – in fact they are simply doing what is right for people, business and the economy.  Debt is always tied to ability to repay through asset value or income.   Anything else would be tantamount to negligence resulting in immediate bankruptcy.

Back to the Mauldin letter.  He points out a quote from 2009 Carmen M. Reinhart and Kenneth Rogoff from their new book, This Time is Different.

“As for financial markets, we have come full circle to the concept of financial fragility in economies with massive indebtedness. All too often, periods of heavy borrowing can take place in a bubble and last for a surprisingly long time. But highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked.

And these three from a group of five points that summarise why leverage is a problem that is not possible to grow out of.

  1. We glean five important factors from this work that pertain to our present situation. First, financial imbalances occur when aggregate domestic debt is excessive relative to income, regardless of whether the government or private sector is accumulating the debt. Once debt becomes excessive, countries do not grow their way out of the problem; they must go through the time consuming and often painful processes of debt repayment and increased saving.
  2. Second, whether the domestic debt is externally or internally owed is not as critical as the excessiveness of the debt.
  3. Third, government actions, even involving sizeable sums of money, are far less helpful than they appear. As the book states, “Infusions of cash can make a government look like it is providing greater growth to its economy than it really is.”

Relevance to Bankwatch:

The three points above are important.  They are conclusions based on research of eight centuries of economic crises.  In short, no debt is good whether personal or government, when it exceeds ability of income to repay.  Sounds like banking 101.

This analysis simply supports my increased belief that as consumers increase debts again in 2009/10 this cannot continue without some impact while governments are doing the same thing.   It will be important for banks to consider alternative product design that takes a longer view that is in the best interests of everyone’s best interest.

Written by Colin Henderson

January 24, 2010 at 17:27

Posted in economy

JAL imminent bankruptcy is yet another indication of a changing world economic landscape

I continue to be of the view that we are in the early stages of a revolutionary period and that the companys which survive will not be the ones that composed the DOW/ FTSE/ Nikkei indexes of the last 30 years. There is a shift occurring and the economic crisis is only a symptom, as global balances shift and move in ways we cannot even comprehend today.

Anyhow, in related news, yet another bastion of the old economy is in dire straits. JAL (Japan Air Lines) began in 1951, first flew to San Francisco in 1954, and in 1987 became 100% public owned. In 2002, JAL took over JAS (Japan Air Systems). 2009 November was their worst financials.  JAL stock has dropped from ¥210 to ¥4 today.

Anecdotal evidence suggests that even government employees have been abandoning JAL for competitor ANA recently.  Listening to my wife, there is a tremendous sense of patriotism and loyalty to JAL and they have continued to disappoint, yet this is a big day in Japan as they watch this situation unfold.

Out with the old companys and in with the new … banks, are you watching?

JAL plans radical cuts as bankruptcy looms

JAL’s expected filing for court protection from its creditors is one of Japan’s biggest corporate failures. The government is preparing at least Y900bn ($9.9bn) in new equity and credit lines to keep the airline operating while in bankruptcy.

Researched by Nobuyo Henderson

Written by Colin Henderson

January 19, 2010 at 02:46

Posted in economy, Japan

Tagged with , ,

Bank of Canada joins other Central Banks is calling for caution

In the regular Monetary Policy Report the Bank of Canada keeps their focus on a low interest rate environment right through 2010.

On inflation the view is mixed …

The main upside risks to inflation relate to the possibility of a stronger-than anticipated recovery in the global economy. A stronger global recovery would be transmitted to Canada via trade, financial, confidence, and commodity price channels. There is also the risk that Canadian domestic demand could be more robust and have a more sustained momentum than projected.

On the downside, a stronger-than-assumed Canadian dollar, driven by global portfolio movements out of U.S.-dollar assets, could act as a significant further drag on growth and put additional downward pressure on inflation. Another important downside risk is that the global recovery could be even more protracted than projected if self-sustaining growth in private demand, which will be required for a solid recovery, takes longer than expected to materialize.

Worldwide consumer demand rejuvenation is not assumed in the near term …

Vigorous and coordinated fiscal and monetary policy stimulus in the G-20 economies, including a wide range of measures to support the fl ow of credit, have been sustaining aggregate demand, but evidence of self-sustaining private demand remains modest. Necessary adjustments on both the real and financial sides of the global economy are under way, and will involve a significant and protracted rotation of global demand, as well as deleveraging by U.S. and European banks, households, and firms.

Canadian consumer confidence is very real estate focussed due to affordability.


On capacity …

After reviewing all the indicators of capacity pressures and taking into account the weakness in potential output associated with the ongoing restructuring in the Canadian economy, the Bank judges that the economy was operating about 3 1/2 per cent below its production capacity in the third quarter of 2009, in line with the July projection.

This chart is worrisome though, begins to sow seeds of doubt. Consumer credit is growing but business credit is lagging. Consumers are increasing mortgage debt but not purchasing ‘things’ – (sound familiar – 2007?)


On money supply enormous growth, but suggestions the money is being parked – i.e. low velocity of money suggesting low prospect of near term inflation.

The monetary aggregates have continued to grow strongly. In the three months to August, the narrow aggregate M1+ grew at an annual rate of 18.2 per cent, while M2++ grew by 7.0 per cent. It is diffi cult to assess the implications of monetary expansion for economic activity, since the demand for money is likely to be abnormally high in an environment of very low interest rates and tight credit conditions. The continued robust growth in narrow money reflects the desire of both households and firms to keep money in liquid assets until it is clear that the economic recovery is taking hold. Consistent with our base-case projection, the growth in money balances is expected to gradually decline over time.

On GDP – this is a very clear depiction that consumer spending has been replaced by government spending, and that won’t change consequently until 2011. The other factor also noted here is that currency shifts and changes in imports/ exports will be the real next thing that determines each country’s economy



On consumer confidence 2 …

In the wake of a short, severe recession, and with residual economic uncertainty, the personal savings rate remains elevated over the projection horizon.

Monetary Policy Report Oct 2009 mpr221009.pdf

Written by Colin Henderson

October 22, 2009 at 22:35

Posted in economy

Tagged with , , ,

The Real Cause of the Financial Crisis | Global Labour Supply Shifts

Over at Econbrowser Menzie highlights this new paper from two Profs, and someone from the NY Fed (no title). It closes the loop for me on something thats been bothering me about economists and the financial crisis. The debate about the cause of the crisis vacillates between Greenspan and loose credit, versus, global imbalances and Chinese who save too much. Neither of these resonate much, appear as reactions to a situation, and are therefore more symptomatic than causal.

From the abstract to Why are we in a recession? The Financial Crisis is the Symptom not the Disease!, by Ravi Jagannathan, Mudit Kapoor, and Ernst Schaumburg:


This paper lays the cause of the crisis on the increased labour supply in developing countries. Now this sounds more like a root cause. Things are no longer manufactured in Pittsburgh, but now China. That labour supply in China is net new to the world. There could be a debate about whether that represents an increase in labour supply, or transfer of labour supply.

In what follows we argue that this huge and rapid increase in developed world’s labor supply, triggered by geo-political events and technological innovations, is the major underlying force that is affecting world events today.2 The inability of existing financial and legal institutions in the US and abroad to cope with the events set off by this force is the reason for the current great recession: The inability of emerging economies to absorb savings through domestic investment and consumption caused by inadequate national financial markets and difficulties in enforcing financial contracts through the legal system; the currency controls motivated by immediate national objectives; the inability of the US economy to adjust to the perverse incentives caused by huge moneys inflow leading to a break down of checks and balances at various financial institutions, set the stage for the great recession. The financial crisis was the first symptom.

In my simplistic interpretation of that, globalised labour supply got ahead of globalised finance. Yes there are international financial markets and products, but to what extent do they factor in the new value transfer from developed to developing countries.

Relevance to Bankwatch:
In any event, I will leave the economic analysis to experts. What matters is the extent that the labour supply shifts are indeed the root cause, because that cause remains in place, and is unresolved. It will not be solved by new bank regulation. Nor can we expect banks to solve it. The instability which results will continue, and that is the reality Banks must operate within.
why are we in a recession labour markets jagannathan090309 (3).pdf


follow up – root cause of crisis – capital reserves, capital flows:

The end of financial globalization 3.0?

What followed was financial globalization 3.0. Emerging markets heeded Martin Feldstein’s advice and took out an insurance policy against the vagaries of financial globalization.[2] By running current account surpluses, intervening in foreign exchange markets and building up currency reserves Asian and other emerging economies were sustaining export led growth and buying insurance against future financial instability. These policies turned developing markets into net capital exporters to the developed world, mainly to the US. Between 1990 and 1998 – during what I have termed financial globalization 2.0 – emerging and developing economies (according to the IMF classification) were running an average current account deficit of about 1.7% of their GDP. Between 1999 and 2008 – during financial globalization 3.0 – this deficit turned into a surplus of 2.5% of GDP.[3]Just like its predecessor, financial globalization 3.0 seemed a success story for a while, generating financial stability and high rates of economic growth. Yet the accumulation of large war chests of foreign reserves through currency intervention carried negative externalities. The arrangement opened up a Pandora’s box of financial distortions that eventually came to haunt the global economy. The glut of savings from emerging markets has been a key factor in the decline in US and global real-long term interest rates – despite the parallel decline in US savings.[4] Lower interest rates in turn have enabled American households to increase consumption levels and worsened the imbalance between savings and investment. And because foreign savings were predominantly channeled through government (or central bank) hands into safe assets such as treasuries, private investors turned elsewhere to look for higher yields. This led to a more general re-pricing of financial risks and unleashed the ingenuity of financial engineers to develop new financial products for the low interest rate world – such as securitized debt instruments.[5]

Written by Colin Henderson

October 13, 2009 at 00:59

Trends that lead to lower growth, lower profits and lower volatility for banks than during the past few decades | Deutsche Bank

This paragraph from the report below, succinctly summarises the growth prospects for Banks, and the backdrop to planning. Again, a plan that looks like the plan for 2007 is destined to fail. This is the time for breakout product design, and a dramatic cost reduction through shift to reliance on internet and online banking for a far greater breadth of service delivery.

Global banking trends after the crisis | Deutsche Bank Research

Lean years lie ahead for US banks. Performance improvements during the last 15 years have often been due to strong lending growth and low credit losses. As private households reduce their indebtedness, revenue growth in some European countries but especially the US may remain depressed for several years. With weak loan growth and a return of higher loan losses as well as a fundamentally diminished importance of trading income and modern capital market activities such as securitisation, banks may be lacking major growth drivers.

global banking trends after the crisis

Written by Colin Henderson

September 2, 2009 at 22:19

Canadian Banks have a Productivity Gap relative to the US

Following up on the previous post covering the Bank of Canada’s view that Canadian Banks do not have a productivity gap [pdf 19 pages] relative to US Banks, here is the basis for that contention within a 2006 report.

The conclusion copied here in whole is in my view, woefully misleading and contradictory. It reads to me like someone with political motivations has turned facts into something that meets policy objectives. Analysis to follow.

This work examines the efficiency and productivity of Canadian and U.S. banks in three ways.

First, we compare key performance ratios and find that (i) the average Canadian bank employee produces more assets than the average U.S. bank employee, and (ii) in terms of producing net operating revenue, Canadian and U.S. bank workers are similarly productive.

Second, we investigate whether there are economies of scale in the cost functions of Canadian banks and a sample of U.S. BHCs. We find larger economies of scale for Canadian banks than for the U.S. BHCs. This suggests that Canadian banks are less efficient with regard to the scale of their operations and would have more to gain in terms of efficiency benefits from becoming larger.

Third, we measure cost-inefficiency in Canadian banks and in U.S. BHCs relative to the domestic efficient frontier in each country (the domestic
best-practice institution). We find that Canadian banks are closer to the domestic efficient frontier than are the U.S. BHCs, and that they have moved closer to that efficient frontier over time.

Overall, these results do not suggest relative efficiency or productivity gaps in the Canadian banking industry. On the contrary, Canadian banks compare generally favourably.

Finally, as noted above, legislative and regulatory changes have benefited efficiency in Canadian financial services. This shows the importance of removing any remaining restrictions that inhibit competition and efficiency, but provide little (or no) benefit in terms of financial soundness.

Some facts from their report:

  • Expense ratio Canada – 67 cents per dollar of revenue
  • Expense ratio US – 59 cents per dollar of revenue
  • Assets per employee Canada – $6.1M
  • Assets per employee US – $4.1M
  • operating revenue per employee US/ Canada same at $0.3M

This from the report:

Our analysis indicates that the difference in the expense ratios can be currently attributed to a higher labour cost component (wages and benefits) at Canadian banks. However, this differential does not imply disparities in productivity, which concerns how much output is produced per unit of input (typically, labour).

Relevance to Bankwatch:
Translation. Bank of Canada views Canadian Banks as productive by taking the narrow view of relative employee output. However that view excludes the overall budget of banks that includes real estate, and technology. The latter points explain the overall expense disparity per dollar of revenue earned at a significant 8 cents.

In other words productivity is a measure of investment not of employees. That is the entire point of automation. This further explains the contradictory point in he Tim Lane Kingston speech that wrote off StatsCan concerns for Canadian Bank productivity.

Productivity is a measure of inputs (expenses) and outputs (revenue). Any narrower view does a disservice to the country and the Banks, covering over potential areas for concern. Banks in Canada cover a large geography with relatively small population and while internet adoption is high the related savings in real estate and technology efficiency have yet to be achieved.

Written by Colin Henderson

August 29, 2009 at 17:25

Posted in economy

Tagged with , , ,

The Canadian Economy Beyond the Recession | Bank of Canada

In this talk at Kingston last Tuesday, Tim Lane, Deputy Governor Bank of Canada lays out a quite lucid view [ 9 pages] of the opportunities and challenges facing Canada in recovery.


  • labour productivity and output is the fundamental challenge that existed before and will continue post recession
  • the size of the working population is to decrease significantly for demographic reasons, and neither immigration nor baby boomers remaining longer in the workforce will significantly alter that prediction
  • the financial services industry is critical to Canada at 20% of the economy
  • Canadian producivity has been dropping because of insifficient investment in technology and lack of innovation. Productivity is further hampered by por re-allocation of capital and labour across industries and this is exacerbated by the recession. Think auto employees in Oshawa having to move to mining in the prairies.
  • The financial services sector productivity is described as particularly worrisome:

How productive is the Canadian financial services sector? Data from Statistics Canada point to a possibly worrisome trend. Productivity growth in this sector has declined from an average of 2.8 per cent per year in the 1990s to just over one-half per cent in this decade.

  • Lane goes on to effectivley dismiss that StatsCan assessment with based on a BofC 2006 survey. I located the referenced BoC paper, and will review that later. It is also attached below. I note it is 3 years old, and thats an odd comparison to a 2009 StatsCan survey.

That said, if we compare Canada with the United States, our own research suggests that generally, the productivity of Canadian banks compares favourably with the productivity of U.S. banks.

Relevance to Bankwatch:
All in all the main concerns are the labour market, overall productivity, the financial services sector, and potential for inflation; he counters the latter with the Banks capability for Quantitative Easing which Canada has largely not employed yet.

recovery canada aug 2009 tim lane kingston r090828e.pdf
canadian bank productivity 2006 research_1206.pdf

Written by Colin Henderson

August 29, 2009 at 16:54

Posted in economy

Tagged with , ,

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