Wednesday Night #1535

It’s pretty scary out there. If you look at the historical data, every single time that growth has dipped below 2% (stall speed), the economy has entered a recession within 12 months. Today the policy makers have absolutely no tools left to deal with another recession. This is what Martin Barnes means by the final chapter in the Debt Supercycle story.  There is a very strong chance that the market will decline 10-20% because of the significant likelihood that the U.S. will find itself in a recession, however the chance of a world-wide recession is not so great and there should be buying opportunities within the next two months.

Gerald Ratzer introduced Mario Iacobacci, noting that he has recently accepted the co-presidency (with Catherine Gillbert) of the Oxford-Cambridge Society, and pointing out that Mario has three degrees (he holds a Ph.D. in Economics from Cambridge University), three languages and great business experience, which included working at the Conference Board of Canada with Guy Stanley.  Mario now leads the economics practice of AECOM across Canada.

 The evening began on an unusual note – Turkey Vultures – and no, not related to the debt crisis or politics. Robert Galbraith mentioned that the birds are being seen in the Montreal area, especially on tops of large building, like the falcons at Place Victoria and the Sun Life building. Watch for Robert’s article on the topic in the Gazette in 10 days. [Update: story first published in the Regina Leader-Post ]

The U.S. economic outlook – gloomy

The usual self-correcting market forces (lower wages, lower housing prices and lower US dollar) may not be strong enough to pull the economy back towards full employment and we are likely looking at many years of persistent suboptimal economic performance and a high unemployment rate.
Following the 11^th-hour resolution of the debt ceiling crisis, a double dip recession is not expected by the WN economists (or at least those present), but they predict a very slow growth period. The Fed could and should be much more aggressive, but the political will isn’t there. Substantial Quantitative Easing is off the table. Much as the economy needs stimulus, it isn’t going to get it.
Of more concern would be the rating of U.S. Treasury Bonds.  Moody’s have maintained their AAA rating but their outlook is negative.  What will S&P do? [Editor’s note: we found out on Friday – see U.S. economy 2011 – credit rating)   Many organizations use T-Bills as collateral and are mandated only to buy AAA rated bonds.  If S&P down rates them, then the borrowing cost will go up for many.
The latest problems in the U.S. could well bring the U.S. growth below 2% and closer to another recession.  The policy makers in Washington have run out of tools to control the current problems. [Editor’s note: Nouriel Roubini made this point six weeks ago in ‘Black swan’ events and the global economy  this time around policymakers are running out of ammunition, and thus may be unable to trigger more asset reflation and jump-start the real economy. This lack of policy bullets is reflected in most advanced economies’ embrace of some form of austerity, in order to avoid a fiscal train wreck down the line.] There is no appetite for more stimulus, which would add to the debt and would not be effective.  Interest rates are essentially zero and cannot go any lower.  Unemployment is at 9.2% and there is no sign of any substantial improvement soon.  And there are no tax hikes, or closing of loopholes that the Republican Congress will approve.
Others put a more positive spin on the situation.  There is a new head of the IMF.  There is lots of liquidity in the financial system.  The U.S. companies have improved their balance sheets and have much cash on hand and are buying back their stock.  However, there is no increase in the number of credit-worthy borrowers.  What is needed is more jobs, so people can pay off their personal debts and/or borrow again.
There are still (highly specialized) opportunities in the U.S. employment market. The example was given of two young McGill graduates (with four degrees between them) who arrived in California in October with no jobs and in a few months – she was working at Google and he with Crystal Dynamics of Tomb Raider – Laura Croft fame.
It is unlikely that QE3 will bring a stimulus package.
Car purchases remain steady at about 14 million units a year.  There is no demand for new housing and few housing starts (a major multiplier industry).  Unless there is hiring soon, this points to a possible recession.
The U.S. banking system in particular has been growing too fast.  There are too many U.S. banks (some 8,000) and many have very low ratings and need to be rescued by the FDIC. Also, U.S. banks are sitting on cash, but are not lending – the problem is lack of credit-worthy borrowers. There is plenty of liquidity, but it flows to the sure bets.

Housing
Our economists are not very optimistic on the U.S. housing situation.
There does appear to be an increase in the number of rental unit apartment buildings to meet the needs of the many people, including those in the Sun Belt, who have lost their homes and now must rent. Moreover, even among those who can afford it, a portion of the aging population is divesting itself of the responsibilities – and uncertainties – of home ownership.
One consequence of the sub-prime débacle that is often overlooked is that much of the U.S. labor force has lost its traditional mobility (video) because many home owners are stuck with mortgages that are under water; people are tied to their homes, because they can’t sell them, and thus cannot move to where the jobs are.
Is there a need for an economic analysis, both in the US and Canada, to resolve the bleak situation?  There is no theory on what people expect – namely to live comfortably.

The economic outlook for Europe

In Europe, where the economy is slowing, the concern of default has shifted from Greece to Italy and Spain – much larger economies. [See Debt crisis in Europe: Worries grow of spread to larger economies of Italy, Spain] The problem in Europe is that the ECB is trying to find the right balance for national debt problems.  Investors would like 10% return, but the country trying to repay its sovereign debt would be unstable.  At 4% it is stable, but the risk is too high for many banks and investors. Eventually, the solution may be a common E-bond issue in the same way that U.S. Treasuries cover all 50 states.

Investment strategy and currencies

One WN investor has lost faith in the yen, the euro and the US dollar, preferring gold and Canadian gold miners. Another maintains that “Cash is King” and believes the gold price is not sustainable. He also believes the U.S., Brazil, and India are not places to invest. (see video)
Meanwhile, the Chinese economy is growing at 9% and while it may slow a bit, it will be a major support for the world economy.  There will be no crash in China, India or Russia.
And Canada benefits from China’s growth; the U.S. does not.  Energy is still a small percentage of overall costs.
What really matters is Net Debt.  Good investments are U.S. and Canadian corporate bonds.
[Editor’s note: Confirming the views of Wednesday Nighters: Black magic behind the sharemarket carnage]

The Québec Model

Pierre Arbour spoke to his expanded paper on “The Québec Model” related to his presentation at the New School of Athens Montreal Dialogues.  Quebec’s debt is now 100% of its GDP.  The current spending on repairing the infrastructure is just adding to this debt.  GDP growth is about 1.6%, while debt growth is twice this at some 3%. These figures do not include Hydro Quebec’s debt and operations.  The Churchill Falls project is raking in more than 80% of its profits and the HQ debt is perfectly sustainable.  Not so for the province.
Meanwhile, productivity is low and declining, while the population is aging, the birthrate is low and the school drop-out rate is high.
The Plan Nord is a great idea, and not just for Quebec, but also for RoC in the same way that the Ring of Fire chromium deposits in Northern Ontario and the continued development of the oil sands in Alberta benefit the entire country. All these projects will require multi-billion dollar investments in infrastructure, some of which will need to come from foreign sources. And as Canada is a stable country with guaranteed property rights and solid macroeconomic fundamentals, there should be no problem raising the funds.
The James Bay development, a project of the Liberal (Bourassa) government, is viewed by some as having made a great contribution to the development of the area. But others point out that grands projets produce a short term boost for the area in the form of highly-paid construction and professional jobs, but not full time employment for the native or other local populations. [Editor’s note: The Cree did in fact benefit from the James Bay Agreement and have invested much of the money wisely and to the benefit of the population, but not necessarily in a way that has generated employment.]
What about environmental impact? Certainly, this is an issue with the Tar Sands. Do we really want a dam every 15-20 km on all our major rivers? We need to look at what has happened in the rest of the world – China’s Three Gorges, the Amazon Basin ….

Education

Only 57% of Québec students complete high school, while in the rest of Canada the figure is 64%.  However, the Anglophone population of Québec has the same graduation rate as the rest of Canada.
One educator suggested that the education system is not serving teenage students well.  They are all forced to do language and literature while the teenage ‘guys’ are more interested in hands-on, more technical classes.  What is needed is streaming at an earlier age.  Boys adapt to computer usage and lose interest in the language/literature/history classes.  Teenage girls are generally more open to the latter to please their teacher!
Québec is producing too many BA’s and not enough plumbers, welders and other trades people.
Counsellors in the schools may bear much of the blame by pointing students in the wrong direction, telling them “You can be whatever you want!” – rather than exposing them to the realities of where the jobs are and what society needs – would you rather be a plumber at $70/hour or a BA flipping hamburgers at $10/hour?
A former (South Shore) school commissioner pointed out there are 10 times as many bureaucrats in the Quebec education system as that of Denmark.  He also believes that students should be trained for trade skills as needed by Pratt & Whitney and other local industries, but this proposal was rejected by the Ministry of Education. The Ministry of Education is a relatively new concept, dating from the early 1960s [Editor’s note: Paul Gérin-Lajoie was named the first minister of Education in 1964]; prior to that, it was the Catholic Church and a few Scots who ran the education system (McGill is 190

A quick return to Canadian politics with mention of Nycole Turmel, the interim leader of the NDP who appears to be a less-than-serial party member, holding membership in the Bloc Québécois AND Québec Solidaire, in addition to the NDP. Her defense so far has been less than convincing.

The Last Word

Thanking everyone for their contributions, Diana summarized the evening, making the following points:
The intertwined themes of the evening have been The Economy and Education, and in some respects, the Economy versus the Environment.
The outlook for the Economy is generally gloomy. The actions of the U.S. government regarding the debt ceiling have done little to improve the situation. Markets are headed down. Europe is facing  serious problems and so far the ECB is not providing solutions. 
Education remains key to economic prosperity. There appears to be a need to return to the concept of trades guilds whose members have standing and recognition in the broader community. There is much to do to improve our education systems in Canada and Québec. One Wednesday Nighter who is doing more than his share is Pierre Arbour, whose Fondation universitaire Pierre Arbour awards scholarships to Quebec resident graduate students in the three academic disciplines identified as the most likely to foster economic growth: Business Administration (M.B.A.), Computer Science and Engineering.

With thanks to Gerald Ratzer  for notes and Mario Iacobacci  for editing/clarifications

The Prologue

As we write, the bulletins are coming in – it seems that after interminable brinkmanship, there is a deal on the debt ceiling. (Masochists may want to prolong the agony by watching the Brian Williams special on NBC ‘Taking the Hill’: NBC gets  a rare look inside Congress which followed the antics in Congress last Wednesday and was aired on Sunday evening).
Thus it is incredibly timely that Peter Berezin of Bank Credit Analyst will be with us and will give us an overview of this month’s BCA: “Revisiting the Debt Supercycle: What Happens Next”. Quick Summary: Markets are likely to bounce back once a deal is in place to raise the debt ceiling. The latest European bailout package does not address Greece’s solvency problem, but should mitigate contagion risk across the region. While bonds are not seriously overpriced, investors should overweight equities as the global economic recovery picks up steam.
The author of the report, our very OWN Martin Barnes, updates where things stand with the Debt Supercycle, a term that BCA coined several decades ago. He argues that a new era of financial conservatism has begun and that rising government indebtedness is likely to be the final chapter in the Debt Supercycle story. Peter will interpret!
In light of events in the U.S., Jeffrey Simpson suggests that America’s fiscal mess offers long-term opportunities for Canada
“Whether or not politicians cobble together a deal before Tuesday’s debt-ceiling deadline, the long-term U.S. fiscal situation will remain grim. How should Canada respond? … If Canada were smart, it would realize it needs to invest in the things that will make the country more competitive, while we bring down budget deficits by spending less on things that don’t. So an extra dollar spent on education and research will be a dollar well spent, in comparative and competitive terms.” We are sure that few Wednesday Nighters would argue with this part of the article, although there are other statements that might bring some disagreement. Meanwhile, Adam Daifallah, citing Canada’s new lustre in the world argues that “Once harsh critics, American conservatives now look north for ideas on governance and public policy. … As economic confidence south of the border plunges to a 15-year low and the debt-ceiling fiasco edges toward catastrophe, many U.S. experts are praising Canada as an attractive low-tax environment and a beacon for sound fiscal policy and good governance.”
The repercussions of the debt ceiling crisis and the conditions under which it was resolved will no doubt be both long and deep, not only on the economy of the U.S., but perhaps more acutely on the governance of what today gives every appearance of a dysfunctional and ungovernable republic . In this regard, we believe that Michael Gerson’s article in the Washington Post: The stranglehold on domestic policy is a must-read, as is the Pew Research Center Report to which he refers.
“This week the fiscal crisis was momentarily interrupted for a public service announcement.
The Pew Research Center issued a report showing that the racial disparity in net worth – the wealth gap in America – is growing. For people of every background, assets declined during the Great Recession, but the liquidation was faster among African Americans and Hispanics.
In 1984, the ratio between white and black wealth was about 12 to 1. Now, the median net worth of whites is about 20 times that of blacks. According to the most recent figures, about 15 percent of white households have zero or negative net worth. The percentage is 35 percent among African Americans.”
Staying on the financial crisis theme, we would like to call to your attention Meltdown, The Secret History of the Global Financial Collapse, the brilliant documentary produced by CBC’s Terence McKenna. (Thank you, Stephen Kinsman.) We also believe it is time to consider Too Much Debt Means the Economy Can’t Grow: Reinhart and Rogoff (sent along by Tony Deutsch from his bucolic retreat).
Kimon reports from Europe: “Just read an article on the implications of the appreciation of the Swiss franc. It would appear that because of the loss of competitive advantage that this appreciation entails, Swiss workers have decided to work three extra hours a week for the same pay. Wow. What an achievement. This is fantastic news for the Swiss worker. Work more and earn less!!!” Does anyone have follow-up information on this startling news?
There is much more happening in the world that deserves our attention. Perhaps now with the (at least temporary) resolution of the debt ceiling crisis, we can turn again to questions of environment, energy, the Arab Spring continuum (Arab unrest, high food prices cast pall on Ramadan) and even some Canadian issues like the Keystone pipeline and the Free Trade pact with the EU about which we seem to know so little.
The Couchiching contingent is off to Orillia for the annual intellectual feast – this year is the 80th anniversary of the grand Canadian tradition. The Conference title is From the Ground Up: Civic Engagement in Our Time and, as usual, the cast is star-studded, although we do wonder about Jim Prentice as an agent of change. We are delighted to note that Stéphane Dion is to be awarded the Annual Couchiching Award for Excellence in Public Policy Leadership – perhaps a vindication of his commitment to the environment?  In any event we will look forward to a full account from Margaret Lefebvre and Liam McHugh-Russell next week.
Two final items – unrelated to any debt crisis. The first is Margaret Somerville’s compelling op-ed Is Jack Layton obliged to disclose his health details? No
The second concerns the fact that the Norwegians are not likely to allow Breivik to get off with an insanity diagnosis. Of course, he is deranged, as is anyone who commits such horrendous crimes, but under the Norwegian system an insanity defense requires that a defendant be in a state of psychosis while committing the crime with which he or she is charged. That means the defendant has lost contact with reality to the point that he’s no longer in control of his own actions. We are curious – can anyone tell us what the definition is under Canadian Law (either or both codes?)?