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

FIFA: Farcically Incompetent Football Administrators

Soccer is the world's most popular sport; nothing else comes close. But the various federations that run the game are astoundingly incompetent and, by all accounts, venal to the point of outright corruption. Worst of all is the global governing body, FIFA, which has been run for years by the odious Sepp Blatter and his cronies. Let's take a look at some of what they've been up to lately.

The Women's World Cup is to be held this year, right here in Canada.  It's going to be played on plastic grass, which is wrong and potentially hazardous. If Canada couldn't provide stadia with real grass for the event, it shouldn't even have been allowed to bid. let alone have emerged as the winner. There are, of course, soccer stadia with real grass in Canada -- Toronto's purpose-built BMO Field for one -- but the tournament has been banished to smaller cities with artificial pitches.  Some of the world's top female players tried to take the issue to court, on the reasonable grounds that nobody would ask the men to play their World Cup on plastic turf, but the case went nowhere.

FIFA never quite seems to be able to take the women's game seriously. It's not that long ago that the aforementioned Blatter opined that the best way to increase the game's appeal would be for the players to wear shorter shorts. Well, if Sepp is planning to pitch up in Canada this summer for a good ogle, he's likely to be disappointed. If the women have any sense, they'll be wearing leggings so as to reduce the risk of turf burn.

Meanwhile, over on the men's side, it's now known that the 2022 World Cup, awarded in highly suspicious circumstances to Qatar, will be played in November and December, the traditional July timing being impractical due to the extreme summer heat in the Gulf.  This will require all of the world's major domestic leagues to take a lengthy time-out in the middle of their seasons; indeed, given that players will probably have to commit to international duties for about two months, it will probably disrupt the previous and following seasons as well. Nice one, Sepp!

Of course, FIFA may face another problem before it even gets to Qatar. The 2018 World Cup is set to be held in Russia, like Qatar the beneficiary of a highly dubious selection process.  Some politicians are already musing about boycotting the event, or even moving it, to punish Moscow for its alleged involvement in the fighting in Eastern Ukraine.  Nothing in Blatter's past suggests he cares in the slightest about the behaviour of host countries, but he and FIFA could find themselves scrambling if any of the major European soccer powers start to put the pressure of for a change of venue.

Ah FIFA. Disrespecting the women's game, messing up the men's. And laughing all the way to the bank as they do so.  

Fed tells Congress: "not yet"

In her semi-annual Humphrey-Hawkins testimony to the Senate (she gets to do it all over again for the House on Wednesday), Fed Chair Janet Yellen indicated that interest rate hikes are still some months away: the central bank is going to remain "patient".  Some members of Congress, especially on the Republican side, are concerned that the Fed may wait too long, only to have to push rates up quickly if inflation rears its head.

It appears that the recent decline in the headline inflation rate, thanks to the collapse in energy prices, has emboldened the Fed to stand pat for a little longer. Over in London, Bank of England Governor Mark Carney recently signalled a similar outlook for UK monetary policy, and as there is zero prospect of rate rises at any of the other major central banks -- the BoJ, the ECB, the RBA -- it looks as though we will be waiting until after mid-year to find out whether anyone really knows how to unwind the stimulus that's now been in place for well over half a decade.

The fact that the Fed is using the low headline CPI as a key justification for standing pat is a little worrisome. Ms Yellen's predecessor-but-one, Maestro Greenspan, was notorious for casting around to find new inflation measures to justify his own predilection for low interest rates.  Remember the ECI (employment cost index)? Or how about the core personal consumption expenditure deflator? Greenspan relied on both of these, and many others besides, at one time or another. In the meantime he applied unnecessary monetary stimulus to the economy, leading to the disastrous consequences that unfolded from 2007 to 2009.

It's unlikely that Ms Yellen is making the same mistake. At the same time, it's hard to avoid the thought that if you really could achieve solid growth with low inflation simply by opening the monetary spigot as wide as possible, somebody would have figured that out years ago. These are extraordinary times, and it's unlikely that getting back to "normality" will be easy or predictable.  Ms Yellen correctly noted that the US employment picture has improved on all fronts since her last appearance before Congress.  Even so, wage pressures remain under control, largely as a consequence of the drastically reduced bargaining power of American workers. There's no imminent suggestion that that's about to change -- though WalMart's decision to boost the pay of all of its "associates" may have a ripple effect -- but it's certainly a key area of risk that the Fed will need to monitor closely.

And what does this mean for Canada?  Bank of Canada Governor Poloz is widely expected to cut rates again next month, and that prospect, together with Ms Yellen's generally upbeat take on the US economy today, is putting the Canadian dollar under renewed pressure. The rapid falls in gasoline prices that we saw a couple of months ago are already starting to reverse themselves, and the currency's sharp decline will add to price pressures at the consumer level in the coming months.  The Bank has warned that headline CPI might slip into negative territory in the spring, but it's unlikely to stay there for very long. Even so, and especially with an election coming in October, rate hikes in Canada are likely to lag the Fed by many months.  

Greek tragedy

You don't say, Alexis!  Greek PM Alexis Tsipras has warned his fellow citizens of "real difficulties" ahead, despite the short-term deal agreed with Eurozone creditors (mainly Germany) on Friday.  Tsipras told the nation that the deal "cancels austerity", but this is far from the truth.  The whole agreement could unravel as soon as Monday if Tsipras's government fails to come up with a fresh list of reforms that must be approved by the Eurozone.  Even if that hurdle is crossed, the extension to the existing bailout package is only for four months, so the pressure to find a long-term solution will ramp up immediately.

Tsipras is facing a tough time selling the deal to the Greek people because he campaigned on putting an immediate end to the creditor-imposed austerity that has crushed the economy, cutting real GDP by more than 25 percent. In truth, this was a promise that was never in his power to deliver. It takes two to renegotiate a debt, and there was little incentive for the Eurozone (i.e. Germany) to go along. Any real concessions would quickly have brought other heavily-indebted nations (Portugal, Spain, maybe even Italy) to the table looking for similar relief. While the "nuclear option" of reneging on the debt was theoretically available (and still is, if the negotiations go nowhere), the consequences of such a move for the Greek economy would have made the country's current problems seem like a golden age.

The uncomfortable truth is that Greece should never have been allowed to join the Eurozone in the first place. It was only allowed to do so because it misled the ECB about its compliance with the so-called Maastricht criteria that were meant to ensure that key economic indicators, notably inflation and public sector deficits, were converging with EU norms. It's worth remembering that it was assisted in concealing the true level of public debt by big US investment banks, who put together some sophisticated (and no doubt very lucrative) swap transactions to conceal the real numbers.

All of that said, there can be little doubt that austerity, particularly to the brutal extent imposed on Greece by its creditors, was precisely the wrong medicine at the wrong time. Now that the economy is prostrate, Greece's debt burden is even more unmanageable than it was before the crisis began.  No doubt all sides will put their best efforts into striking a long-term deal in the next four months, but behind the scenes, both Greece and its creditors will be busy preparing themselves for the possibility of the dreaded "Grexit".  

Irrational exuberance, Canadian style

True story: sitting in a doctor's waiting room last week, I spotted a headline on a the front cover of Canadian Business magazine: "The housing collapse begins". I picked the magazine up and started to read about how the market in Vancouver was starting to implode, with Toronto soon to follow.  All kinds of economists weighed in on how this was the beginning of the end for the overvalued Canadian housing sector.

Then something struck me as being amiss, and I looked at the date on the cover: October 2012! Truth is, despite the big-print headline and all those confident economists' prognostications, that collapse never actually happened. Indeed, in the two markets identified all those months ago as being closest to the edge -- Vancouver and Toronto -- home prices have gone ever higher, outpacing the rest of the country.

It seems more than likely that the divergence in performance between those two cities and the rest of  Canada will continue for a while yet. Although the latest national home price data show that prices nationwide are up by a bit more than 3 percent year-on-year, that number is entirely based on strong advances in Toronto and Vancouver.  Excluding those cities, prices are actually slightly lower than at this time last year. Moreover, sales activity is slipping, with particular weakness seen in Calgary and Edmonton as the impact of falling oil prices starts to be felt in the producing provinces. A surge in new sales listings in Calgary points to further price declines in the coming months.

What does this mean for Bank of Canada policy? Business economists, who to a man and woman failed to predict the Bank's rate reduction in January, are now confident that it will cut rates again in March.  And they may well be right, but I have yet to hear a convincing explanation of why the Bank thinks that further monetary easing is helpful.

As long as oil prices stay depressed, the housing market in Alberta (and Saskatchewan and Newfoundland) will not recover, regardless of where borrowing costs go. At the same time, the markets in Toronto and Vancouver, which even scarily complacent Bank of Canada Governor Stephen Poloz admits are seriously overvalued, will continue to race ahead to even more unsustainable levels. In fact, as this article reports, that's already happening in the Toronto region.

It's getting harder and harder to see a happy ending to this story. The Canadian economy is looking anaemic compared to its neighbour to the south, and the fact that the Alberta housing market has been walloped so quickly by the fall in oil prices provides a clear warning of what could happen elsewhere in the country in the event of an adverse shock.  Expectations that the housing bubble in Toronto and Vancouver can be gently deflated, which never did seem altogether realistic, are dwindling even further as the Bank continues to pump more air into the bubble. It would be no exaggeration to say that the market in those cities is displaying irrational exuberance -- and we know how that plays out.      

Science 101

Earlier this week one of the weather guys over the river in Buffalo, where they know a thing or two about snow, was musing about the problems they're facing in Boston. There has been so much snow in Beantown over the last two weeks that the city is running out of places to put it, so they're thinking of dumping some of it in the ocean.

Of course, said Buffalo guy, they have to be careful about that because of all the road-clearing chemicals that have been ploughed up with the snow, "especially sodium chloride".

Well, quite. It certainly wouldn't do to make the sea salty, would it?