A bad idea that just won't die

I see the folks now working at my old shop, the TD Bank economics department, have put out a report suggesting that the cost overruns and delays that seem to affect all major infrastructure investments in Canada could be avoided if private expertise and money were brought in: public-private partnerships, or P3, as it's known nowadays.

Er, no. Back when I was living in the UK, P3 (or PPP as it was known there) was ubiquitous -- and so were horror stories of how often it failed. I blogged about it a lot at the time: here are a few quotes from some of those posts.

Don't you just hate it when Ken Livingstone's right? Hizzoner was vehemently opposed to the so-called "part privatisation" of the London Underground all along. That may just have reflected his intellectual biases, but there were a lot of people who shared his sense that allowing private sector firms to manage the maintenance and refurbishment of the Tube might be either expensive or a failure. 

It's turning out to be both. Today's Guardian reports that the cost overruns on the two contracts awarded to the so-called "Metronet" consortium could reach £2 billion. Metronet's banks are threatening to pull the plug, and the engineering companies that own the consortium are unwilling to put in more money, so it looks like Transport for London (TfL, aka the taxpayer) will either have to pony up more cash, or scale back the work. 

There must be something I don't understand here. Everyone knows that the Treasury (G. Brown, prop.) forced public sector agencies like TfL to use "public-private partnerships" primarily to keep debt off the Government's balance sheet. But there was supposed to be another element: private sector management was supposed to keep costs down and deliver projects on time, with the private investors taking on the financial risks if they failed to do so. What's happened at Metronet is that the project is being delivered late or not at all, at hugely inflated costs, and the taxpayer is being asked to shoulder the burden of what looks like an abject failure.  (Money down the Tubes, 29 June 2007). 

Not long after that, the inevitable happened: 

Metronet, the consortium holding a contract to maintain about two-thirds of the London Underground, filed for bankruptcy this week after an arbitrator refused to award it extra funds for carrying out the work. Metronet's bankers had previously said they would not extend its line of credit unless it could squeeze more money out of Transport for London (aka TfL, aka the taxpayer). 

I last wrote about this as recently as June 29. In brief, Metronet has spent way over budget while massively underperforming its obligations under the contract. In fact it's done even worse than that, since it has admitted that it was responsible for the recent derailment of a Central Line train, which hit a tarpaulin that Metronet staff had left in a dangerous spot. 

Media reactions to Metronet's collapse are interesting. In an editorial, the Times admits that Metronet has only itself to blame for its failures. However, it argues that this does not invalidate the principle of "public private partnerships" (PPPs), and it comes close to throwing responsibility back onto TfL. According to the Times, the test will be whether TfL can readily find someone else to take on the work. I'm not sure if this is a principle that can be applied very widely: "I'm sorry that your meal cost more than it said on the menu and that you were sick for two days afterwards. No, you can't have your money back, and we're not paying your medical bills, but there's another restaurant down the street that you can try when your appetite returns". 

Jeremy Warner in the Independent's business section has a more reasoned view. He admits that the Metronet fiasco has driven a coach and horses through two of the supposed benefits of the whole PPP approach to public works: that the private sector will do the work more efficiently/cheaply than the public sector, and that if it fails to do so, it will bear the cost. He observes that it seems that the City has, as usual, run rings around the public servants in putting the deal together. 

To me, this last point -- that the private sector will try to bamboozle the public sector in these deals -- almost amounts to sufficient reason not to continue with the whole PPP approach. (I say "almost" because the Government has shown itself quite capable of playing fast and loose with contracts -- take a look at the experience of GNER with its contract to run the East Coast Main Line). There isn't much hope that the Government will abandon PPPs, but we should at least ask if there are any lessons that can be drawn from this episode. 

One that occurs to me is that the Government should choose its partners carefully. Metronet isn't a real company -- it's a consortium put together by five engineering companies solely to bid on the Underground contracts. These shareholders all appear to have limited liability for Metronet's doings. Apparently the Government's negotiators either never heard of, or at any rate did not insist on, things like guarantees, deficiency agreements, covenants or even comfort letters that would have made the partners liable for Metronet's failings. In these circumstances, it was misleading for the Government ever to suggest that the private sector would be on the hook for any cost overruns. In fact, when you consider the huge sums that have already been paid to Metronet under the contract, it's likely that the losses incurred by the partners are quite limited -- and, of course, deductible from earnings elsewhere. (PPP RIP? Probably not, 18 July 2007)

It became clear some time later that all sorts of dubious practices had been widespread:

The private sector has done a pretty good job of trashing its own reputation since the UK Government started privatising the provision of all kinds of public services (the so-called Private Finance Initiative, or PFI). The mega-disasters are well known: the collapse of the Metronet consortium that was selected to run half of the London Underground (it ran out of money and credit only a couple of years into a thirty-year contract); the soaring cost of the privately-run railways, which absorb far more in subsidy than poor old British Rail ever did; the out-of-control BAA monopoly that has made London's airports musts to avoid; and so on. 

It's pretty clear that public sector negotiators have been outsmarted by their private sector counterparts at every turn. Contracts have been let for the wrong term, risks and rewards are hopelessly skewed against the government, and there is an absence of real accountability. 
Now it transpires that things may be even worse than this. Metronet or BAA are clear examples of failures of public-private finance to deliver what was promised at the agreed price. However, even in many cases where the partnership has "worked" in terms of delivering the project without any headline-grabbing screw-ups, it seems as if the public may still have got the short end of the stick. The Office of Fair Trading (OFT) has just accused 112 construction companies of irregularities relating to the bidding process for publicly-funded construction projects. The offences include "cover pricing" i.e. forming cartels with competitors to inflate prices in order to ensure they don't win contracts (no, I don't know why they would do this either -- if you don't want the job, don't bid), and faking invoices in order to compensate losing bidders.  (PFI-ddle, 17 April 2008)

I assume the good folks at TD Economics are confident that Canadian bureaucrats negotiating P3 deals would avoid all of these pitfalls and protect the interests of taxpayers. I'm not sure I'd bet any of my own money on that, but given her recent praise of P3, it looks as though Premier Kathleen Wynne is going to do that for me. 

World Cup in Canada?? Just say no!

Heaven help us, but it seems the Canadian Soccer Association is contemplating making a bid to host the 2016 World Cup tournament. Canada's not exactly a hotbed of soccer fanaticism,  though the level of interest is certainly increasing;  participation in the sport at youth level probably now exceeds that for hockey, which is a much more expensive game for kids to play.  However, it appears the CSA is offended by the fact that Canada is now the only G8 country not to have been afforded the chance to host this quadrennial extravaganza, and wants to put that right.

It's to be hoped someone quietly nips this in the bud before too much money is spent on the bid, because it's such a bad idea. Let me count the ways....

• Canada has a mixed track record when it comes to hosting events of this size. Winter Olympics in Calgary and Vancouver went well enough, although both almost fell victims to unpredictable weather. However, the summer Olympiad held in Montreal all the way back in 1976 was an unmitigated financial disaster, leaving local taxpayers on the hook for decades of debt repayments.

• The conniptions Toronto is currently going through in order to host the Pan Am Games this summer should be a clear warning of the difficulties of staging the much bigger World Cup -- an event that makes the Pan Am Games look like a village fall fair. Although the facilities for the Games should be ready on time, there have been significant cost overruns.  And it's dollars to donuts that the city will be reduced to chaos during the event itself: the newly-announced transportation plan for the period of the Games basically amounts to closing a bunch of roads and asking residents, pretty please with a cherry on top, to stay home.

• The CSA's respect for the sport is shown by its insistence on staging this summer's Women's World Cup on artificial turf,  a decision that prompted the threat of a lawsuit from some of the top players -- supported, it should be said, by many male players who may have feared a precedent was being set. FIFA had no choice but to go along with the CSA because no other country was interested in hosting the event. The fact that the CSA is now airily saying that the playing surface for a men's tournament could be determined after the bid had been won is cause for serious concern -- and should automatically disqualify the bid. 

• Lastly, the CSA asserts that finding eight venues is not likely to be a problem. That's correct, as long as you have an unlimited budget. The only stadium in Canada that's anywhere close to being large enough for a World Cup final is the Stade Olympique in Montreal, which is now rarely used and is in some disrepair. It will be fifty years old by the time of the 2026 World Cup.  The biggest stadium in Toronto, the Rogers Centre, would accommodate maybe 50,000 for soccer, and because it's a dome, it has zero potential for expansion.  The city's purpose-built soccer stadium at BMO Field is currently being expanded -- to hold about 30,000.  There are a few stadia across the country that might be adaptable for World Cup use (Vancouver and Edmonton come to mind) but it's likely that more than half of the venues would have to be purpose built, at huge expense and with little certainty that they would be widely used once the circus left town.

For now, talk of a bid for the World Cup is muted.  If the CSA starts to get serious, expect a major taxpayer revolt against the prospect of having to underwrite such a venture -- which would hardly be good for the future development of the sport in Canada.

Canada's health care myths

A couple of posts ago, I ended a piece on the Canadian prescription drug market thus: "It will be interesting to see whether any of the major parties adopts a commitment to pharmacare as part of its platform for this year's election. There would seem to be a lot of votes in it."  I think I need to walk that back -- quite a long way back.

The fact is, a national prescription drug plan for Canada may be the right thing to do, and opinion polls may show it has widespread popular support, but that doesn't mean it will be a big vote-getter in this year's Federal election.  Who's going to vote for it?

• Seniors?  They traditionally turn out at the polls in higher numbers than other age cohorts, so their support is crucial. But most seniors already enjoy prescription drug coverage. Some may vote for a national program as a matter of principle but for most, to the extent that it's a pocketbook issue at all, it's a negative one, because taxes will have to go up to cover the additional costs to the public sector (estimated  at $ 1 billion) if a national scheme is adopted. 

• The middle classes?  A high proportion of permanently-employed Canadians, especially those in the public sector, have a health insurance plan, often financed on a co-pay basis with their employer. Those plans include prescription drug benefits.  The insurance companies that underwrite the plans are expected to save big-time if a national pharmacare plan goes into effect, but unless you believe that those reduced costs will be passed onto planholders (and if you do believe that, can I ask if you've met any insurance people lately?), there's no obvious advantage to the middle classes in a national drug plan. In fact, to the extent that a national public plan might well cover a much smaller formulary than private plans do, many people with private insurance might actually feel they would be worse off with a public plan.

• The less well-off?  They would certainly benefit the most from a public drug plan. Many of them can't afford prescription drugs at present, and the tax burden of setting up a public plan would mostly fall on the better-off. But the poor tend not to be politically engaged, so it's hard to imagine them turning out in greater-than-usual numbers to support such a plan.

Not many sure votes for any party that supports pharmacare, then.  But in reconsidering my initial take on this issue, I've been forced to focus on the sad but usually ignored truths about Canada's healthcare system in general: it's not very comprehensive, it's not entirely in the public sector any more, and it's not very good.  

The absence of a prescription drug plan is by no means the only hole in Canada's public health system. To take just one example,  there's no publicly-funded dental care of any kind. Anecdotally, dentists and their fellow-travellers (denturists, endodontists, orthodontists and so on) seem to outnumber family doctors by at least two-to-one in our neck of the woods, which gives you some idea of where the big money is to be made.

As for the system no longer being primarily in the public sector, this is evident in a number of ways:

• Almost all ancillary services (X-rays, bloodwork and such) have been contracted out to private labs. This may be cost-effective, but it places a burden on those seeking treatment, who now have to trek from place to place to get work done.

• The growing role of insurance companies in the system is evidence of the mounting inadequacy of the public system.  The very fact that these insurance providers are around seems to provide cover for governments' continual, stealthy reduction in services provided at public expense. 

• Some of the more prestigious specialized hospitals (Princess Margaret Cancer Centre and Sick Children's Hospital, both in Toronto are prominent examples) rely on annual multi-million dollar lotteries to raise funds.  In a properly-funded system this would hardly be necessary. 

Taking all of these things together,  it's clear that what a Federal health minister once referred to as "our magnificent medicare" is, nowadays, nothing of the sort. So what's it like to live under such a system?  Well, maybe I can be allowed to illustrate by reference to the recent experiences of my wife.  

A few years ago, back in the UK, she was diagnosed as needing a hip replacement.  From diagnosis to operation the interval was six weeks. All meetings with the surgeon, pre-op sessions, the operation itself and post-op treatments including physiotherapy took place at our local hospital

Last fall, here in Canada, she was diagnosed as needing a knee replacement. The diagnosis was based on X-rays (taken at a private clinic) and an MRI (at a nearby hospital). Meetings with the surgeon took place in his office, in a medical arts building separate from the hospital. He referred her to an internist in the same medical arts building.  He sent her for further X-rays (same location as the first set) and for heart stress tests (at a separate private clinic in another location). A date for the procedure has finally been set, fully six months after the initial diagnosis -- if she's lucky: the surgeon has already warned us that he had to cancel some planned surgeries at short notice last year because the local hospital ran out of funds!

You could get sick worrying about these things, but that probably wouldn't be wise.   

Definitely maybe

Concerns over the possibility of a rise in US interest rates had caused equity markets to reverse most of their early-year gains in the days prior to Wednesday's Federal Reserve meeting. However, markets staged a minor relief rally when Fed Chair Janet Yellen struck a slightly more dovish tone than investors had feared.

The Fed statement removed the term "patient" in describing the Fed's attitude toward tightening, but Ms Yellen was at pains to stress that this did not mean that the Fed would now be "impatient". Significantly, the Fed lowered its expectations for the upward path of interest rates through 2016, a clear indication that rates will rise more slowly, and possibly start to rise later, than previously expected.

The prospect of continuing low inflation, almost entirely thanks to low energy prices (something the Fed has no real influence over) certainly gives the Fed the luxury of waiting. In other respects, however, the excess of caution is quite remarkable. The US economy is in the middle of an extended string of job gains in excess of 200,000 per month, something not seen since the middle of the 1990s. While wages have remained remarkably tame, it is highly uncertain that this will remain the case if the employment picture remains strong.

At Ms Yellen's recent testimony to Congress, a number of Republican senators urged the Fed to get out ahead of any possible uptick in labour costs, on the grounds that this would reduce the risk of having to hike more aggressively later.  This is not advice the Fed seems likely to follow: it is apparent that Ms Yellen, like her predecessors Ben Bernanke and Alan Greenspan, fears that any strength in the economy (and in equity markets) is almost entirely attributable to the persistence of accommodative monetary policy.  Sooner or later the Fed is going to have to put that proposition to the test by actually raising rates, but it appears Ms Yellen's inclination is to postpone the evil day for as long as possible.

Meanwhile, up here in Canada, the OECD has released a sobering report on the country's near-term economic prospects, cutting its GDP growth forecasts for both this year and next to just over 2 percent. The culprit is, of course, oil, and there are certainly increasing signs that the collapse in global energy prices is starting to take a big toll on employment and exploration in the oil patch. (Think the low-$40/bbl price for benchmark crude is shocking?  The price for a barrel of Canadian heavy crude fell below $30/bbl this week!)

The shocking thing is that the OECD, in line with other forecasters, appears to see little prospect for the manufacturing sector of the economy to pick up any of the slack, despite the 25% decline in the exchange rate over the past year or so.  There could be no greater evidence that the collapse in Canada's manufacturing sector over the past decade is a structural and irreversible trend, rather than simply something cyclical.

Still, not to worry. As always, the housing sector is on standby to bail us out.  With the weather improving, the spring housebuying season is almost upon us, and right on cue, the big banks have lowered their mortgage rates.  You can now get a mortgage for a five-year fixed rate of 2.79%. Canada's household debt/earnings ratio recently set yet another all-time high (it stands at just over 163%), but the banks are apparently unworried about giving borrowers yet another incentive to buy an overpriced home using debt that will quickly become unserviceable once rates start to rise.

Think Fed Chair Yellen has a tough task ahead in deciding when and how far to raise rates without torpedoing the economy? For Bank of Canada Governor Poloz, that task might be just about impossible.

Want a new drug (plan)

Canada is the only country in the world that offers universal public medical insurance, but doesn't cover prescription drug costs.  It makes no sense at all. Studies show that a substantial proportion of the people who are given prescriptions by their doctor don't get the prescription filled because they can't afford the cost. This means the public health plan has incurred the substantial cost of the doctor's time, without the patient receiving any benefit: after all, just sitting in front of a doctor never made anyone well again -- it's the drug he or she prescribes that does that.

Until a few years ago, it seemed as though the provinces, who each manage their own medical systems, were moving closer to providing prescription drug coverage.  Here in Ontario, for example, seniors have their costs covered, subject to a fairly small annual deductible (or "co-pay").  However, in the more straitened fiscal circumstances we've seen recently, progress on this front has stalled, and even shown signs of going into reverse.  In its last budget, Ontario proposed steps to make well-off seniors pay more, a move that is on hold for the time being only because of the difficulty of making the necessary adjustments to the income tax system.

Now we have the release of a major new report that shows that Canadians as a whole would benefit to the tune of several billion dollars if a nationwide, universal pharmacare system were to be set up.  The public sector would be on the hook for an additional $ 1 billion a year, in the researchers' estimation, but the savings for private health insurers would be many times greater. Savings would be achieved through bulk buying of drugs -- at the moment each provincial plan makes its own deals with the pharmaceutical companies -- and through greater reliance on generic drugs.

It seems like a no-brainer, and in any country other than Canada it probably would be. One obvious stumbling block is the Harper government, which has been relentlessly cutting health care standards ever since it came into office, and would be very unlikely to support any new spending in the field. Longer term, the fragmented provision of health care by individual provinces would pose an even bigger obstacle: the likelihood that the individual health fiefdoms would agree to the compromises and co-operation that a national scheme would require must be rated as very slim. Finally, of course, it's unlikely that the drug companies, already among the biggest lobbyists in the country,  will sit idly by and watch Canada set up a scheme whose effectiveness in effect relies on reducing their profits.

It will be interesting to see whether any of the major parties adopts a commitment to pharmacare as part of its platform for this year's election. There would seem to be a lot of votes in it.

Selling the furniture to buy gin

Many years ago, at the height of the privatization mania that swept around the world, a colleague of mine scornfully described the practice as "selling the furniture to buy gin". You were trading in valuable assets for one last fix of a guilty pleasure you couldn't really afford. Not that this deterred anybody back in the day: enthusiastically led by the Thatcher Tories in the UK, governments all over the globe sold off everything from airlines to utilities to the highest bidder.

Privatization is not so much in vogue nowadays, though it's still favoured as a policy option for cash strapped governments: one of the demands that the so-called "troika" made of the Greek government is that it should sell off some of the more idyllic Aegean islands to foreign investors.  And there are few governments around the world more desperate for cash than the Province of Ontario. In the wake of years of spending that would shame a drunken sailor* and some ill-considered tax cuts, Canada's most populous province is saddled with a huge deficit and debt that the recently re-elected Liberal government has pledged to rein in by 2018.

Spending cuts won't do the job, and significant tax hikes are a no-no. so the government is looking at selling off (or "monetizing", as it prefers to say) some publicly-held assets. Some of what's on the block clearly belongs in the private sector -- the liquor monopoly, for example -- but there are other assets that most Ontarians seem to prefer to keep in public ownership, if polls can be believed.

The biggest of these "crown jewels" is Hydro One, a successor corporation to the former Ontario Hydro, which was broken up (partly with a view to eventual privatization) more than a decade ago. Hydro One handles almost all of the high-voltage transmission in the province, and also has a couple of subsidiaries that function as local power utilities. Those subsidiaries are certain to be sold off, but it now appears that the government is looking at options to sell off a big chunk of Hydro One itself as well.

Truth to tell, I don't have a strong opinion either way here: I can make a case for keeping companies like Hydro One in the public sector, but I can equally make a case for why it would be better off in private hands. It's clear to me, however, that there's a very good chance that the Liberals will screw this up -- and all to raise an amount that is really fairly insignificant in the contest of the province's fiscal problems.  Here are a few considerations:

•  Screwing up the energy sector is what the Liberals do best. The cancellation of planned gas projects before the last provincial election but one, a decision made entirely for partisan advantage, cost taxpayers over a billion dollars in contract breakage and other fees.  Before that debacle, the Liberals embarked on a push for renewable energy that has led to skyrocketing electricity bills for both households and businesses. This has contributed in no small way to the meltdown of Ontario's manufacturing sector.

•  It appears that the favoured approach will be a selloff of a portion of Hydro One, rather than the whole. That portion could be as high as 60%, with the province retaining 40%.  There would also be restrictions on how much any other shareholder could own. This is supposed to protect and reassure the public, but of course if the other shareholders banded together they could outvote the government on key issues. The government could protect itself by retaining a so-called "golden share", as happened in some UK privatizations, but of course, if it does that, there's no obvious reason not to sell off the entire company.

•  No sane investor really wants to be a junior partner with government anyway, so the Province's insistence on retaining a big piece of the pie will inevitably reduce the amount that can be obtained for whatever part is sold. The Province's assurance that the existing regulatory regime will remain in place will have the same effect -- and without providing any real comfort to consumers who've seen power prices soar under that same regime over the past decade. 

•  If Hydro One is valued at $16.5 billion (CAD), as experts seem to believe, then sale of a 60% stake would raise $10 billion for the provincial treasury. Chunky, right? Well maybe, but consider that the Province's outstanding debt is $350 billion, and the projected annual deficit for the coming year is $12.5 billion. You'd be selling off a majority shareholding in an important piece of infrastructure that's been in public ownership for a century and more, and not even raising enough money to keep you in gin or whatever your poison may be for even a year.

There's going to be a big brouhaha if the privatization plan goes ahead. There'll be knee-jerk opposition from media outlets such as the Toronto Star; Hydro One's unions will be outspokenly opposed; and there are even signs that the supposedly right-wing Tory opposition may opportunistically come out against a sale that you'd think they would be ideologically likely to support. The process, if it happens, is likely to be formally announced as part of the provincial budget, expected in May. The Liberals have an overall majority, so they'd be able to force this through, but the political costs are likely to be severe.


* No insult to inebriated matelots intended: I'm aware that, unlike politicians, sailors on shore leave spend their own money.  

Dissing Governor Poloz

So it's not just me, then. Since Stephen Poloz took the reins at the Bank of Canada almost two years ago, I've written a number of blog posts questioning his approach to the job.  But I'm no longer in the bond business and I'm not a big institutional investor, so I don't suppose the Governor has lost much sleep about it.

Ed Devlin just might be a different story. The fixed income manager at investment giant PIMCO has told Bloomberg that he's getting out of Government of Canada bonds because of the unpredictability of Poloz's public policy pronouncements.* The knock on Governor Poloz -- and Ed Devlin (and I) are not alone in thinking this -- is that he announced last year that the Bank would no longer be providing "forward guidance" to markets about the likely direction of interest rates. However, he seems to honor this approach as much in the breach as in the observance.

The fact that the market was surprised by the Bank's rate cut in January certainly speaks to the absence of any clear policy signals. However, Poloz's subsequent comments initially led markets to expect a further rate cut in March, but then changed tack to indicate that the Bank would prefer to wait to assess the effectiveness of the January move.   The Bank stood pat in March; now, the market consensus seems to be that there may not be any further rate cuts by the Bank, though some analysts still expect a further reduction as early as April.

Not that "forward guidance" is the key to a harmonious relationship between central banks and bond markets. Just ask Poloz's predecessor as Governor, Mark Carney, now plying his trade at the Bank of England. Soon after moving to London, Carney introduced guidance to the Bank's armoury. Specifically, he indicated that the Bank would closely monitor the UK job market, and would consider moving interest rates higher once the headline unemployment rate slipped to 7 percent, on the assumption that such a jobless rate would likely be accompanied by rising wage pressures.

The Bank of England's own forecasts when Carney made this announcement suggested that employment growth would not trigger a rate hike for several quarters. In the event, however, job growth turned out to be much stronger than the Bank had anticipated, and markets began to price in a rate hike more than a year ago. It still hasn't happened: wage pressures in the UK have remained well-contained, and now, of course, the fall in oil prices is pushing inflation ever lower. "Forward guidance" is now a discredited concept in the UK, and Carney's relationship with parliamentarians and pundits alike has yet to recover.  It's possible that Gov Poloz had Carney's UK experience in mind when he dropped forward guidance from the lexicon in Canada.

So what are we to make of Ed Devlin's decision? It may be that he's trying to re-elevate PIMCO's profile, which has taken a knock since the departure of the eccentric but influential Bill Gross and the ubiquitous Mohamed el-Erian.  After all, Devlin isn't getting out of Canada altogether: he claims he sees better value in provincial bonds and bank paper. Those certainly yield a bit more than Canada bonds do, but if Devlin is looking for a peaceful, less volatile existence, they're surely not the place to hide. By far the biggest determinant of the yield on such "spread product", and the biggest driver of day-to-day price movements, is .....the performance of Government of Canada bonds!  


*Unless Ed Devlin is the world's worst bond trader, and I'm certain he isn't, the Bloomberg article should say that he's "got out", not "getting out". If you're as big a player as PIMCO, you can't tell markets in advance what you're planning to do, unless you want to lose money.  

Bank of Canada policy, wrongly explained for you

In line with the hastily-revised expert consensus, the Bank of Canada left its benchmark interest rate unchanged at 0.75% today, saying it needed more time to judge the effectiveness of January's 25 basis point reduction. The non-move caused the Canadian dollar to rally very slightly, which is not something the central bank wishes to see, given that it is counting on a revival in non-oil exports to get the economy moving again.

By coincidence (or not), today saw a highly misleading article in the Toronto Star's op-ed page on Bank policy, penned by two left-leaning policy wonks. Their thesis is that the Bank is "quietly moving to the left" and adopting policies that have long been advocated by the NDP, Canada's main socialist(ish) political party.

This is simply wrong. The Bank's mandate for many years, as agreed with the Federal Government, is to keep inflation as close as possible to 2 percent.  When inflation is above this level, the Bank takes steps to bring it down, by tightening monetary policy (i.e. raising interest rates). When inflation falls below 2 percent -- and right now Canada is flirting with outright deflation, thanks to the fall in global energy prices -- the Bank tries to boost the inflation rate, by cutting interest rates. Notionally, this works by stimulating the real economy, but in Canada's case the most immediate impact on inflation is likely to be the result of a declining exchange rate.  None of this has anything to do with the NDP's supposedly superior policy prescriptions.

It's worth noting that it's not just in Canada that below-target inflation is giving central bankers pause. In the US, low inflation is allowing the Fed to delay rate hikes much longer than markets had expected, in order to allow the employment situation to improve further.  Over in the UK, Bank of England Governor Mark Carney has explicitly warned of the possibility of a brief period of deflation before underlying price pressures reassert themselves. There, too, the unexpected fall in inflation has stayed the central bank's hand.

The real problem with the Star op-ed piece is that the authors are claiming credit for a policy that hasn't really worked, and probably won't work any time soon. Low interest rates may be a necessary condition for getting the economy moving again, but the fact that the Bank of Canada is contemplating further cuts half-a-decade into the low rate era surely demonstrates that it's not a sufficient one. As Keynes and others observed long ago, expansionary monetary policy is like pushing on a string.

What's missing is an accompanying fiscal push. For ideological (but not economically logical) reasons, Canada's federal government has spent the past several years reducing spending in order to wipe out the budget deficit: the wrong policy at the wrong time. Low interest rates afford governments the opportunity to stimulate aggregate demand at minimal financial cost to taxpayers. Even in the Middle Ages, monarchs understood that the best time to rebuild the navy was when the economy was in bad shape, but right-wing governments in Ottawa (and in London) have been willfully blind to that truth.

Come October, the NDP can try to sell the case for more stimulative fiscal policy to the nation's voters. Given the extent to which the Harper government has poisoned the debate, that's likely to take more than a few ill-thought-out op-ed pieces in the Toronto Star.

Will he or won't he?

The Bank of Canada's next rate-setting decision day is Wednesday, and market watchers are resiling en masse from their earlier forecasts that Governor Stephen Poloz would announce another rate cut.  These are, of course, the same market watchers who were stunned when Poloz cut rates back in January.

The revision in the market consensus for this week's meeting is mainly based on comments Poloz made last week, to the effect that the Bank would take the time to assess the effectiveness of the January cut. A stand-pat outcome is also suggested by the latest GDP data, released today, which appear to show that the economy held up rather better than expected in the final quarter of 2014.  GDP rose 0.3% in December , giving an annualized rate of 2.4% for the quarter -- much closer, it may be noted, to Gov Poloz's most recent estimate of 2.5% than to the market consensus of 2.0%.

Given the collapse in oil prices, one of the biggest surprises in today's data is the strength shown by the oil and gas sector, though that strength was concentrated in the early part of the quarter, and there were greater signs of weakness by year end. Some media reports are suggesting that the oil patch -- and particularly the oil sands -- can live perfectly well with oil prices in the $50/bbl range.  Even so, it seems inevitable that exploration activity, though probably not production, will be reined in during the first half of this year.

Which sector stands to take up the slack if the energy sector slows? Despite hopes that the weakness in the exchange rate might provide a boost, it seems unlikely to be manufacturing. The RBC purchasing managers index (PMI) slipped to its lowest-ever level in February,  signalling a modest contraction in the manufacturing sector. As I have endeavored to point out many times before in this blog,  the collapse of manufacturing in southern Ontario and else where in the past decade is not simply a cyclical thing. In the words of Professor Bruce Springsteen*, "these jobs are going, boys, and they ain't coming back".

Truth to tell, rate cuts can't do anything for the oil patch, and there's not much they can do for the manufacturing sector either, at least in the near term.  That doesn't mean Gov Poloz won't pull the trigger again:   the consensus, for now, seems to have shifted to a move in April, though it's not clear how much more the Bank of Canada will know by then. It does mean, however, that the health of the economy will come to depend more and more on the housing sector -- which itself depends on a prodigious level of household indebtedness.

*"My Hometown", from the album Born in the USA