Sunday, 4 December 2016

David Dodge's growth plan

Something that's been evident since the great global experiment with ultra-loose monetary policy began almost a decade ago is that no-one at the major central banks has any clear plan for getting policy back to "normal".  It might have been easy to do so if low rates and QE had quickly restored growth to pre-crisis levels, but of course that didn't happen.  We now have a world of low interest rates, low inflation (apart from asset prices) and stagnant growth, and central banks have little or no ammunition available in the event of another crisis.

Enter, with an important speech last week to the CD Howe Institute in Canada, former Bank of Canada Governor David Dodge.  The media have focused mainly on his call for the Fed, and if possible other central banks, to abandon their current data-driven policy approach, in favour of a pre-announced schedule of rate hikes, designed to bring rates back to a more normal level.  This would certainly create room for easing the next time things head south, but Dodge's rationale is a lot more subtle and complex than that.

Dodge characterizes the macro policy paradigm that served the global economy well from the early 1980s until the onset of the financial crisis as "leaning against the wind".  Monetary policy, and to a lesser extent fiscal policy, were aimed at keeping economies on a path of steady growth and stable inflation.  However, in the past few years, that paradigm has proved ineffective:

"In large part, changing demographics, slower technological progress, and inadequate structural policies have contributed to lower potential growth. In addition, deleveraging by households and banks in the wake of the financial crisis, the structural debt crisis in the eurozone, and the slowdown of trend growth in China are factors that hampered global growth. In addition to lower potential growth, the “natural rate” of interest is lower today than it was in the decade that ended in 2007."

Dodge's explanation for the lower "natural rate" of interest is heavily driven by demographics. An aging population naturally starts to save more, thereby increasing the supply of investible funds. At the same time, that shift from consumption to saving serves to reduce profitable investment opportunities within the economy, driving down the demand for funds. The real "natural rate" of interest may now be 1 percent or even lower, as against 3 percent two decades ago.

One of Dodge's key arguments is that low interest rates, and especially the expectation that they will stay "lower for longer", are now in and of themselves holding back growth, in  a variety of ways.  Low rates work in part by "pulling forward" investment and consumption plans -- borrow while you can afford it -- but if, as is now the case, those low rates are expected to persist indefinitely, that incentive is reduced. Moreover, an aging population sees low rates as a clear signal to save more for retirement.  A low rate, flat yield curve environment makes it difficult for banks to make profitable long-term loans, because mismatching (using short-term deposits to fund longer-term assets) is no longer effective.

To this one could add (though Dodge does not) the demonstration effect of central bank policies themselves. If central banks are constantly signalling their lack of confidence by extending their ultra-loose policy settings, why should consumers or businesses feel confident enough to spend and invest?

Dodge's solution to this dilemma is to throw out the paradigm.  On the monetary policy side, get away from the current data-driven approach and announce a schedule for future rate hikes to get the Fed funds rate up to 1.5-2.0 percent.  To offset the negative impact of such a strategy on economic growth, fiscal policy should be loosened, with a focus on public sector investments designed to boost the longer-term growth potential of the economy.  (Dodge duly notes that this is the approach that the Canadian Federal Government seems to be taking).

It would, of course, be foolhardy for the US to undertake such a course, particularly on the monetary policy side, on its own.  Higher US interest rates, without corresponding moves elsewhere, would inevitably serve to strengthen the US dollar, which would crimp US exports and also pose potentially severe problems for emerging economies.  This is probably the major flaw in Dodge's plan: it all makes good sense, but in a world where governments don't trust one another and central banks prize their independence above all else, how can you ever expect to make it happen?  

In point of fact, something along the lines that Dodge is bravely advocating here may be about to unfold in the US anyway.  Nobody seems to doubt that the Fed will raise rates this month and will continue to tighten through 2017.  On the fiscal side, Republicans always run bigger deficits than Democrats, whatever their campaign rhetoric may have been, and Donald Trump's infrastructure renewal plan seems to be one of the few things that all sides are willing to support.  What's lacking here is any kind of international co-operation, which is something that Trump seems to go out of his way to alienate.  How will a rebalancing of US policies work when most of the rest of the world is sticking to the old paradigm?  We may be going to find out.  

Friday, 2 December 2016

It's all good, on the surface

Canada's economy added 10,800 jobs in November, pushing the unemployment rate down to 6.8 percent.  That's a good thing, right? Well, not exactly.  I've noted here many times that Canada's labour force survey is so volatile as to be almost incomprehensible, but in this case the details point very clearly to one conclusion: the job market is not as healthy as it seems on the surface.

For one thing, all of the new jobs were part-time in nature, as indeed they have been for the past year and more.  For another, the fall in the unemployment rate was almost entirely the result of workers leaving the labour force altogether, which usually means people are giving up looking for work because they have little expectation of finding any.  Then again -- and this is where the unfathomable volatility of this series is so frustrating -- labour force participation had seemed to be improving in recent months, so the decline in November may just be an anomaly, rather than a new, unfavourable trend.

The employment numbers were the second release from StatsCan this week that may not have been quite as good as they first appeared.  On Wednesday the agency reported that GDP grew at a 3.5 percent annualized rate in Q3, way ahead of the analysts' consensus.  Moreover, the wildfire-driven decline in Q2 GDP, originally reported at an annualized 1.6 percent, was revised to 1.3 percent.  The principal driving factor, no surprise here, was a 6.1 percent rebound in energy exports, as the area around Fort McMurray returned to normal activity levels.

What's next?  Probably not more of the same.  Although GDP grew 0.3 percent in September, setting up a strong base for Q4 growth, the improvement in the month was yet again largely down to the energy sector.  Stripping that out, real GDP only rose by 0.1 percent in the month, suggesting yet again that the Bank of Canada's and the government's hopes of seeing the economy rebalance away from its dependence on resource extraction continue to be unfulfilled.

In fact, events may be starting to conspire against that rebalancing happening at all.  This week's OPEC production cut, if it holds (a huge "if") will give a boost to Canada's oil patch.  Just the prospect of that happening has pushed the Canadian dollar back above 75 cents (US), eroding the exchange rate competitiveness that is supposed to give sectors like manufacturing a boost.

And then, of course, there's the Trump factor. The President-elect's condemnation of the NAFTA trade agreement has been mainly aimed at Mexico, but Canada is also a signatory to that deal. There's no realistic possibility that any revision of that deal, assuming that Trump doesn't just cancel it outright, will work in Canada's favour.  In the absence of NAFTA, the US will still be willing to accept Canadian energy exports, albeit in declining amounts as US production continues to ramp up.  For other sectors, however, especially manufacturing, the prospect of a post-NAFTA world is truly worrying.  Bank of Canada Governor Stephen Poloz says it's too soon to tell what the Trump impact on Canada will be.  Maybe so, but it's not too soon to fret about it.  

Wednesday, 30 November 2016

It's not about the pipelines

Justin Trudeau's government delivered its long-awaited verdict on three pending pipeline projects yesterday, approving two (Trans Mountain and Line Three) and nixing one (Northern Gateway). Right on cue, protesters immediately took to the streets, in Vancouver and elsewhere, to protest the government's temerity in approving any pipeline construction at all.

I don't suppose Trudeau and his colleagues need me to tell them this, but here goes anyway: for environmentalists, opposition to these projects (or to the much bigger Keystone XL pipeline, which may be revived under a Trump presidency) is not about the pipelines.  The environmentalists want to see fossil fuel use phased out as quickly as possible, so they are opposed to anything that allows fossil fuels to be brought to market.  There is no compromise possible here.  If God were to come down from heaven and declare that the Trans Mountain pipeline would never leak, the environmentalists would still oppose it.  They want the fossil fuels to stay in the ground.

The fact that many indigenous communities are also opposed to pipelines -- in the ongoing Standing Rock confrontation, or in the areas in northern British Columbia that have successfully seen off the Northern Gateway project -- is a blessing for the environmentalists.  It allows them to cloak their opposition with a higher cause: native rights.  Truth to tell, however, if the Standing Rock community did a U-turn and decided to support the pipeline, the environmentalists would abandon them in a trice and find another basis for their opposition.  They just want the fossil fuels to stay in the ground.

What about those indigenous groups and their own objections to these projects?  Some of the fears over the potential for polluting vital watercourses are undoubtedly justified, but there's more to it than that.  These communities would be no happier if the proposed project was a railway across their territory, or an airport*.  Once again, it's not really about the pipelines.

I'm probably giving the impression here that I'm all gung-ho to build pipelines hither and yon, and damn the ecology.  Far from it: as the leader of Canada's Green Party, Elizabeth May, has pointed out, with world fossil fuel consumption seemingly having peaked, with fossil fuel supplies abundant, and with the cost of renewable energy falling fast, the economic case for any of these pipelines is far from being established.  Any or all of them may turn out to be a white elephant from day one.

The truth is that "debate" and "compromise" are no longer terms that have any relevance when it comes to pipeline projects, because one side has its mind firmly made up.  That being the case, Trudeau's announcement yesterday just sets the stage for endless rancorous legal debates in the months and years to come -- and by the time any of the projects is approved, let alone built, the economic rationale will very likely have dwindled even further.  

* Or, as The Donald may be about to discover, a wall.  There's a 70-mile stretch of the US-Mexico border that's part of a historic, treaty-protected indigenous homeland.  The people there are determined not to allow Trump or anyone else to put a wall across their land, and the courts will very likely support them.

Monday, 28 November 2016


We need a new word for something that I did for much of my career as a business economist.  A big part of the job is to try to estimate what key economic numbers will be before they're actually released by the statistical agencies.  This may sound pretty futile to the non-specialist -- why not wait until the real number comes out, and then you'll know for sure? -- but in fact it's one of the key ways an economist can contribute to the bottom line, especially in a dealing room.

How is that possible?  Well, markets don't just react to economic data in a vacuum.  Traders try to set themselves up ahead of time, in order to profit from the data if they've figured it out correctly.  This means that the market doesn't react to the data per se -- it reacts to how the data differs from the market consensus.  A business economist who can estimate the data releases better than his or her peers will therefore set the traders up to make more money than the competition.

You may have noticed that I have been trying hard not to use the word "forecasting" for this function -- because it's not, is it?  You'll regularly read things in the business press like "economists forecast that GDP grew 1.2 percent in the third quarter of the year; official data will be released today", even though the quarter for which they're "forecasting" ended two months earlier.  There's an old saying that "forecasting is difficult, especially when it's about the future"; the customary inaccuracy of the "analysts' consensus" for economic releases often suggests that "forecasting" the past isn't much easier.

What brought on this mini-rant was this story from the Toronto Star today.  It appears that the OECD is going out on a limb and "forecasting" that the Canadian economy "will" grow by 1.2 percent -- THIS YEAR!  By my count there are 33 days left in the year, so for the most part, whatever is going to happen has already happened.  It's not exactly brave, and it's not going to cause anyone to change their behaviour.

So, as I said, we need a new word for this vital but slightly bizarre activity -- but "pastcasting" probably isn't it.

Thursday, 24 November 2016

Was this what you voted for?

The UK economy has held up surprisingly well since the Brexit referendum back in June, leading many of the pro-Leave side to start crowing "I told you so".  But wait....

Chancellor of the Exchequer Phillip Hammond, unveiling his Autumn Statement (i.e. mini-budget) this week, revealed that economic weakness and uncertainty caused by the Brexit vote will boost government borrowing by more than 120 billion pounds in the years ahead.  Plans to eliminate the budget deficit -- which previous Chancellor George Osborne originally promised to have got rid of by now -- have gone by the wayside.

Now the Institute for Fiscal Studies is warning that the squeeze on real wages triggered by Brexit will be the worst the UK has seen since the aftermath of World War II.  A lot of the older folks who voted Leave seemed to be hankering after an idealized vision of what Britain was like in their youth.  Looks like they're going to get it.  It may not be quite as idyllic as they remember it.

Sunday, 20 November 2016

Donald Trump, theatre critic

US commentators are amused and slightly alarmed that President-elect Trump is wasting his time and his self-imposed Twitter ration on going after the cast of the Broadway musical Hamilton, for supposedly harassing Veep-elect Mike Pence.  See this piece from Slate, for example.

Should anyone really be surprised by Trump's behaviour here?  I'd say not.  In the first place, the man is remarkably thin-skinned, a trait which is unlikely to do him any favours once he actually assumes office.  More importantly, though, I suspect Trump is setting a precedent for how he will behave in the White House.  

It's difficult to imagine a less Trump-friendly crowd than the people attending a hip-hop musical on Broadway: aside from Mike Pence and his party, you could probably count the number of GOP voters in the house on Friday night on the fingers of one hand.  Criticizing people like this plays really well with Trump's electoral base, and he's not about to stop.  The more he can portray his opponents as sore losers, the easier it will be for him to blame them when the wheels start coming off his administration -- which, given the Cabinet of Deplorables he seems to be putting together, may not take long. 

The precedent here, as it has been for much of the US election cycle, is the Brexit vote.  Leave campaigners have wasted no time in rounding on the Remain voters,  or on anyone they deem insufficiently keen to leave the EU:  Bank of England Governor Mark Carney, for example.  The tabloid press has demanded that the "Bremoaners" shut up, and one Tory MP has even suggested that opposing Brexit should be a treasonable offence.  This all sets things up for a nasty bout of finger-pointing (or worse) when the UK economy starts to feel the negative impact of the Brexit vote, as it inevitably will.  

Populists always have to smear their foes at every turn in order to keep their supporters riled up.  For Donald Trump, the Hamilton cast is a convenient early target.  It surely won't be the last. 

Monday, 14 November 2016

Uncomfortably dumb

The Provincial government in Ontario, under the leadership of Kathleen Wynne, is wildly unpopular.  Ms Wynne's personal approval rating is below 20 percent, badly trailing the leaders of the two main opposition parties -- who are not exactly well-liked themselves.  So, with a provincial election now less than two years away, the Liberals are starting to come up with cockamamie schemes to try to win back support.

One of the main reasons for the government's unpopularity is the soaring cost of electricity, which is, now more expensive here than anywhere else in North America.  The price increases are largely the result of the ill-considered "green" measures instituted by Ms Wynne's predecessor, Dalton McGuinty.  He mandated the immediate closure of coal-fired power generation and shoveled vast sums into unreliable wind power, which people in rural areas like mine have been trying to fend off ever since. Ontario routinely sells surplus power below cost to neighbouring jurisdictions.

What to do?  A few months ago, Ms Wynne announced that the Province would remove the provincial portion of the so-called harmonized sales tax (HST) from household electrical bills.  That was good for a few upbeat headlines, but it didn't take long for people to realize that the pennies-per-day benefit of this cut would be immediately outweighed by fresh "green" levies that have already been approved.  Despite the tax cut, Ontarians will be paying more, not less, for power in 2017.  

Today, Wynne's Finance Minister, Charles Sousa, tabled his fall Economic Statement.  A couple of weeks ago, Sousa trailed the idea that housing in Toronto was becoming unaffordable for first time buyers, and hinted that he was going to try to do something about that.  Today we find that the "something" is a doubling, to $4000, of the existing rebate on the land transfer tax paid by first time buyers, to be financed (allegedly) by a higher tax rate on more expensive homes.

Politicians never learn, do they?  The most certain consequence of a tax break like this is that the asking price for starter homes in the Toronto area will rise by $2000 almost overnight.  That's bad enough, but consider this: a few weeks ago, Federal Finance Minister Bill Morneau announced a tightening of mortgage rules mainly aimed at first-time buyers, with the aim of curbing the unsustainable rise in house prices.  And today we see Sousa, whose jurisdiction includes the frothiest market of them all, Toronto, introducing a measure that will have precisely the opposite effect.  Brilliant!