Wall Street and Main Street – the disconnect.

Excellent video from The Economist regarding the disconnect between Wall Street and Main Street i.e. Stock Market and the Economy. The S&P 500 is up 38% since the middle of March this year when the US economy has been going through one of its worst recessions. The US Federal Reserve had a role here by providing aid packages so the increase in the S&P was seen as a Fed rally and not from normal fundamentals.

The Economist magazine nudge readers to opt for digital subscription

Last week I received a letter from The Economist to renew my subscription and noticed how it had changed from previous years – see 2019 and 2021 renewal letters

The Economist – 2019 subscription
The Economist – 2021 subscription

Notice the following:

  • They have moved away from 3 to 2 options in 2021.
  • They have still left the Print only edition on the subscription letter even though it is not available. This is showing the customer that they are getting a very good deal with the Print & Digital package.
  • In 2019 the Print & Digital package is more expensive than the Print alone option.
The Economist renewals for 1 year.

With the increasing cost of print media I believe The Economist is trying to nudge subscribers to the Digital option by making the price of the Print version (although not available) the same as the Print & Digital. Therefore the Digital subscription is part of both available options.

But there are those subscribers that still like the hard copy every week in their letter box but the fact that they are getting the digital version free (if you compare it to the Print only discontinued option) it might nudge them go onto The Economist website and read the magazine through that medium i.e. the Internet. The bonus is if they like the digital version they get rewarded by saving NZ$90 when compared to the Print & Digital option. No doubt The Economist will acquire subscribers email addresses and send them news, offers etc. in the hope of getting them to subscribe to the Digital only option. If the Print option is no longer offered will the price of the Digital option stay the same? I guess not.

Why does Japanese public debt have little impact on bond yield levels?

Japan is top of the table in accumulating government debt and with a record stimulus to cushion the impact of COVID-19 it is approaching debt levels of 250% of GDP. So how does Japan manage to keep its government bond yields so low (see graph below) and investor confidence high that it can avoid default?

Source: FT

To finance this debt, the Japanese government issues bonds known as JGBs. These are snapped up in enormous volumes by the Bank of Japan (BoJ), the country’s central bank that is officially independent but in practice closely co-ordinates economic policy with the government.

Bond Prices vs Yield

Like any investment the buyer of the bond wants to get the greatest return. Bond prices and interest rates (yield) move in opposite directions and an easy way to consider this is zero-coupon bonds. Here the interest is derived by the difference between the purchase price of the bond and the value of the bond on maturity.
Bond price $920 – Maturity value $1000. The bond’s rate of return = (1000-80 ÷ 920) x 100 = 8.7% return. However a lot depends on what else is happening in the bond market. If interest were to increase and newly issued bonds were giving a return of 10% the 8.7% return is no longer attractive. To match the 10% the original bond price would have to decrease to $909. The bond’s rate of return = (1000-909 ÷ 909) x 100 = 10% return

Reasons for low rates on JGB’s

Japanese Government Bond (JGB) is a bond issued by the government of Japan. The government pays interest on the bond until the maturity date. At the maturity date, the full price of the bond is returned to the bondholder. Japanese government bonds play a key role in the financial securities market in Japan.

The BoJ has recently been buying up billions dollars of Japanese government bonds keeping interest rates around 0% in the hope of increasing the inflation rate to its 2% target. Therefore any rise in bond yields triggers a buy action from the BoJ. As of 2019, the central bank owns over 40% of Japanese government bonds. The BOJ’s government bond holdings rose 3.4% from a year ago to 486 trillion yen ($4.5 trillion) as of March 2020, roughly 90% the size of the country’s economy, according to the central bank’s earnings report for the previous fiscal year.

The economics of transfer deals – Sevilla FC

A colleague forwarded me link to the BBC sport website concerning the work of Ramón Rodríguez Verdejo aka Monchi. Monchi spent 11 years as player at Sevilla (goalkeeper) but is recognised more for his role at Sevilla’s sporting director. When appointed Sevilla were in the Spanish second division and Monchi studied clubs like FC Porto and Lyon who won titles but were able to sell top players and replace them with similar quality players for less money. His first signing was Dani Alves who six years later went to Barcelona for £30m a profit of £29.7m – other signings by Monchi are listed in the table below which equates to and overall £189.75m profit.

Sevilla was relegated from the top flight at the end of the 1996–97 season but returned to La Liga in 1999 with a policy of sell and grow. Since then they have won the following:

  • Copa del Rey in 2007 and 2010;
  • Uefa Cup in 2006 and 2007;
  • Europa League in 2014, 2015, 2016 and 2020.

Monchi pulled off another profitable transfer this season which saw Ivan Rakitic return to Sevilla for a second spell. Originally the Croatian was signed for £2.1m from Schalke in 2011 and then sold to Barcelona for £15.3m in 2014. In September this year Sevilla resigned him for £1.36m and still playing very good football at 32 years of age.

Do the new signings perform?

The website ‘Total Football Analysis’ looked at how well Monchi’s signings performed – this included five years at Sevilla (2012/13 to 2016/17) and two years at AS Roma (2017/18 to 2018/19) – he returned to Sevilla in 2000. His time at AS Roma was not as successful as at Sevilla.

How ‘Total Football Analysis’ judged the success of his signings was by using the metric: the percentage minutes played versus the price that was paid in the transfer market – see graph below. So logically the more expensive the signings the greater the minutes played. The players in red are AS Roma and those in blue are Sevilla FC.

Upper-left quadrant – poor signings as they are players with an above-average price (more than 7.63 million euros) who played below average minutes (39.24%).

Even if we are taking five seasons at Sevilla and only two at Roma, most of the players in the upper-left quadrant are Roma players. Only Ciro Immobile, Joaquín Correa and Paulo Henrique Ganso could be considered very bad signings for Sevilla in this period, while Roma in only two seasons had Patrik Schick, Javier Pastore, Grégoire Defrel, Rick Karsdorp, Cengiz Ünder, Davide Santon and Juan Jesus in the same list. 

Lower right quadrant – excellent signings. Those are players with a below-average price who played a higher than average percentage of minutes. This time, plenty of Sevilla players make the list, but only three Roma players: Aleksandar Kolarov, Federico Fazio and Nicolò Zaniolo.
Lower left quadrant – cheap but didn’t play much, which could mean they were supposed to play that role or were bad signings
Upper right quadrant – expensive signings who played a lot of minutes as there were high expectations.

The correlation between price and percentage of played minutes is represented with the green line. Curiously, the correlation is very low for Monchi’s signings, showing the price is a very bad predictor of players performances in his case. Part of this is because of his high spending at Roma on players who couldn’t make an impact. This reinforces what we suggested before: Monchi proved to be much better at signing lesser-known players for cheap fees than at making high-profile signings. 

Money velocity – you can’t have your cake and eat it

This post refers to Unit 4 of the CIE A2 Economics course. Velocity of circulation of money is part of the the Monetarist explanation of inflation operates through the Fisher equation:

M x V = P x T

M = Stock of money
V = Income Velocity of Circulation
P = Average Price level
T = Volume of Transactions or Output

For example if M=100 V=5 P=2 T=250.   Therefore MV=PT – 100×5 = 2×250
Both M x V and P x T are equivalent to TOTAL EXPENDITURE or NOMINAL INCOME in a given time period. To turn the equation into a theory, monetarists assume that V and T are constant, not being affected by changes in the money supply, so that a change
in the money supply causes an equal percentage change in the price level.

The speed at with which money goes around the circular flow is a significant indicator as to the economic activity of an economy. Money’s “velocity” is calculated by dividing a country’s quarterly GDP by its money stock that quarter – the bigger GDP is relative to the money supply, the higher the velocity.

Recessions – dampen the velocity by increasing the attractive of a store of value. People tend to save rather than spend. E.G. The Great Depression and the GFC. See graph for US velocity of money.

Covid-19 – with the closure of a lot of businesses and people worried about job security personal savings increased to 33.6% of disposable income. Also consumers didn’t have the money to spend.

The stimulus measures and the glut of dollars could cause problems once the consumer confidence starts to become prevalent. Inflation will inevitably rise again – which is not a bad thing considering the threat of deflation that we are currently experiencing. But the major concern is if the increase in spending spirals out of control with high inflation. It seems that central banks want the velocity of money to increase to kick-start the economy but they will need to consider how to control it if it gets above the ‘speed limit’. “You can’t have your cake and eat it”.

Source: Why money is changing hands much less frequently – The Economist 21-11-20

King’s College rowing challenge 2020 – 7×7 – 7 marathons in 7 days

After the 100k challenge last year, Jim Potts (Former Director of Sport at King’s and now at St Patrick’s College in Queensland) and I set a challenge for 2020 – to row 7 marathons in 7 consecutive days. This week we completed the challenge and would like to thank those who have joined Jim and I at various times both in Queensland and Auckland for the past seven mornings.

In Auckland special thanks to Daryl Williams (every morning), Allan Robertson, Dan Rattray, Brendan Boreham, Scott Palmer, Onosai Auvaa,  Mal Bish, and Steve Davison who have joined me on the erg. Also those that have dropped by in support and the rowing club for their encouragement. Photo from Day 3 – I am at the end with the white cap.


 The idea behind the event is to raise money for Friedreich’s ataxia research –  link below:
 
https://give.curefa.org/team/329597

Covid-19 stimulus vs GFC stimulus

Below is a useful diagram from McKinsey & Company that compares the money used to assist the economies after the outbreak of Covid-19 and the GFC in 2017. Governments allocated US$10 trillion for economic stimulus in just two months—and for some countries, their response as a percentage of GDP was nearly ten times what it was in the financial crisis of 2008–09.

Countries in Europe have allocated around US$4 trillion which is approximately 30 times than that of the Marshall Plan in today’s value – the Marshall Plan was valued at $15bn in 1948. The size of government responses are unprecedented and they, with central banks, are moving into new territory. Global debt is estimated to reach US$300 trillion by the March quarter in 2021 with global GDP taking a huge hit. However unlike the GFC there seems to be an end point once an effective vaccine has been found but many jobs and businesses have gone and it will take time before new ones appear.

Is China still influencing the value of the yuan?

I have blogged quite a bit on this topic and refer back to a very good video clip from PBS Newshour on how the Chinese authorities influenced the value of the yuan back in 2010.

Basically at 9.15am the Peoples Bank of China (Central Bank) and the SAFE (State Administration for Foreign Exchange) issues a circular to all the trading banks stating that this is the exchange of the Renminbi to the US$ for today. When companies sell goods overseas the US$ etc that they acquire are then exchanged for Renminbi with the Central Bank – therefore the Central Bank accumulates significant amounts of US$.

Today it could be said that China has done well economically relative to other countries largely due to its large trade surplus. However one would think that with a large trade surplus the yuan would increase in value as there is a greater demand for the currency in order to buy China’s exports. This raises the question as to whether China has been manipulated its currency in order to maintain its competitive edge in the export market.

  • When a country’s currency is getting too strong the governments/central banks sells its own currency and buys foreign currency – usually US$.
  • When a country’s currency is getting too weak the governments/central banks sells its foreign currency – usually US$- and buys its own currency.

For two decades until mid-2014 China’s prodigious accumulation of foreign-exchange reserves was the clear by-product of actions to restrain the yuan, as the central bank bought up cash flowing into the country. A sharp drop in reserves in 2015-16 was evidence of its intervention on the other side, propping up the yuan when investors rushed out. Since then, China’s reserves have been uncannily steady. This year they have risen by just 1%. Taken at face value, the central bank seems to have refrained from intervening. That is certainly what it wants to convey, regularly describing supply and demand for the yuan as “basically balanced”.
Source: The Economist – “Caveat victor” – October 31st 2020

With the surge in China’s trade surplus the yuan has remained fairly stable and with this you would expect that there would be an increase in foreign exchange reserves with Chinese authorities buying foreign exchange with yuan.

A couple reasons why this may not be the case:

  • Commercial banks foreign assets have increased by US$125bn since April. The commercial banks are state owned so it is plausible that the government has used them as a substitute. Adding these foreign reserves to the offical figures suggests invention to keep the yuan at an artificially lower rate. There is the possibility that the central bank has special trading accounts at the state banks. Also exporters have wanted to keep their US$ as they are worried that the disharmony with the US could damage the yuan.
  • The central bank made it cheaper to short the yuan in forward trades – shorting a currency means that the trader believes that the currency will go down compared to another currency.
  • Chinese officials want the yuan to be volatile but within a narrow range in order to convince other countries that they are not intervening whilst persuading people in the market that they will intervene if necessary.

Caught between a rock and a hard place

The Peoples Bank of China (PBOC) are trying to protect domestic producers by keeping a weak yuan so to make Chinese products attractive to overseas buyers. At the same time they are trying to prevent domestic capital from flowing too quickly out of China to stronger currencies. However a longer term scenario is that China would like the yuan to be more prevalent as a currency in the global market. The yuan currently accounts for approximately 2% of global foreign exchange reserves, although by 2030 it is estimated that it will account for 5% to 10% of global foreign exchange reserve assets.

Source: The Economist – “Caveat victor” – October 31st 2020

Addressing savings glut needs more than monetary policy

Today central banks have a limited toolkit and the powers to deal with the savings glut (see image below), lack of investment, climate change and income inequality. There is a lot of money in the system but the velocity of circulation is slow – MV=PT – and this is one reason why we have little inflation.

Velocity of circulation of money is part of the the Monetarist explanation of inflation operates through the Fisher equation:

M x V = P x T

M = Stock of money
V = Income Velocity of Circulation
P = Average Price level
T = Volume of Transactions or Output

Add to this COVID-19 and the impact it has had on especially developing economies and we have economic stagnation.

Source: Bloomberg Economics

Some economists have suggested the need for more expansionary fiscal policy as well as structural reform to achieve economic growth. The latter being a long-term policy can take the form of price controls, management of public finances, financial sector reforms. labour market reforms etc. Although the US Federal Reserve is adopting a flexible average inflation target to avoid a disinflationary environment it will not be enough to deal with secular stagnation.

Secular stagnation
Since the GFC in 2008 it is evident that low interest rates are the new normal and according to Larry Summers (former Treasury Secretary) we are in an era of secular stagnation. This refers to the fact that on average the ‘natural interest rate’ – the rate consistent with full employment – is very low. There can be periods of full employment but even with 0% interest rates private demand is insufficient to eliminate the output gap. The US was in a liquidity trap for eight of the past 12 years; Europe and Japan are still there, and the market now appears to believe that something like this is another the new normal.

Paul Krugman suggests that there are real doubts about unconventional monetary policy and that the stimulus for an economy should take the form of permanent public investment spending on both physical and human capital – infrastructure and health of the population. This spending would take the form of deficit-financed public investment. There has been the suggestion that deficit-financed public investment might lead to ‘crowding out’ private investment and also how is the debt repaid? Krugman came up with three offsetting factors

  1. When the economy is in a liquidity trap, which now seems likely to be a large fraction of the time, the extra public investment will have a multiplier effect, raising GDP relative to what it would otherwise be. Based on the experience of the past decade, the multiplier would probably be around 1.5, meaning 3% higher GDP in bad times — and considerable additional revenue from that higher level of GDP. Permanent fiscal stimulus wouldn’t pay for itself, but it would pay for part of itself.
  2. If the investment is productive, it will expand the economy’s productive capacity in the long run.This is obviously true for physical infrastructure and R&D, but there is also strong evidence that safety-net programmes for children make them healthier, more productive adults, which also helps offset their direct fiscal cost (Hoynes and Whitmore Schanzenbach 2018).
  3. There’s fairly strong evidence of hysteresis — temporary downturns permanently or semi-permanently depress future output (Fatás and Summers 2015).

Source: “The Case for a permanent stimulus”. Paul Krugman cited in “Mitigating the COVID Economic Crisis: Act Fast and Do Whatever It Takes” Edited by Richard Baldwin and Beatrice Weder di Mauro

Bloomberg Economics – Yellen, Summers Say Central Banks No Match for Savings Glut

A2 Economics – Economic Rent and Transfer Earnings

Economic Rent and Transfer Earnings To most of us “rent” is defined as a periodical payment made for the use of a particular asset – usually a residential or commercial property. However, the concept is not limited to land or buildings because it can also be applied to the other factors of production. When a factor is earning more than its supply price, it is receiving a part of its income in the form of economic rent. This situation arises when demand increases and supply cannot fully respond to the increases in demand. For example, labour already employed will experience an increase in income so that they must be earning more than their supply prices.

Present Wages – Wages when initially employed = Economic Rent

The minimum payment required to prevent a person transferring to another employer or another occupation is know as transfer earnings. It is determined by what the factor could earn in its next best paid employment. Transfer earnings may be regarded as the opportunity cost of keeping an employee in their present job or it may be regarded as the employee’s supply price in their present occupation. For example, if the minimum weekly wage that would persuade someone to work as a shop attendant is $200 but he or she actually receives a wage of $250, then the transfer earnings amount is $200 and he or she is receiving $50 in the form of economic rent. Therefore, economic rent can be defined as any payment to a factor of production that is in excess of transfer earnings.

The graph below shows the demand and supply for labour. The equilibrium wage is $120 with a quantity of 50 units. Total earnings is equal to $120 x 50 units of labour = $6,000 and employees receive the same wage of $120. However, all workers except the last one taken into employment were prepared to offer their services at wages less than $120. Therefore, provided the supply of labour slopes upwards (i.e. it is less than perfectly inelastic) an increase in demand will give rise to rent payments to those factors that were already employed at the original wage of $120. The area of economic rent and transfer earnings is shown in the graph below. Only the last labour unit employed earns no economic rent because the wage of $120 is the supply price to that particular labour unit.

Inelastic and Elastic labour supply

The amount of economic rent and transfer earnings in the return to labour depends upon the elasticity of supply and the level of demand. The greater the occupational mobility of labour, the smaller the element of economic rent. If labour can do a variety of occupations then quite small changes in the wage rate will cause large movements of labour into an industry when wages rise, and out of that industry when wages fall.

Very specialised labour has an inelastic supply curve. This includes surgeons, top CEOs, scientists and jobs that require high skill levels or involve significant danger and skill, eg, deep sea divers. The relatively high rewards to this labour are due to the fact that they are in very scarce supply relative to the demands for their services. Their transfer earnings will be much less than their salary because the market values outside their own specialised professions are probably very low. A frequently quoted example of earnings that contain a large amount of economic rent are those of top sports people. Today these people can earn significant amounts of money in a short period of time. A footballer such as Christiano Ronaldo earns €326 923 per week because of his ability to attract big crowds, merchandise sales and sponsorship deals when he was at Real Madrid Football Club. His skill levels are unique and in very limited supply when considering other players. This reflects a very high marginal productivity leading to a higher wage.

Some other occupations that are held in high regard by society do not command such high salaries because of their low marginal productivity. This includes nurses, firefighters, teachers, etc. Furthermore, the supply of labour for these jobs tends to be elastic because there are many people to choose from, unlike their footballing counterparts who have unique skills.

Quasi rent

Where the supply of labour is less than perfectly elastic an increase in demand will lead to some workers receiving economic rent. This rent may be of a temporary nature, however, because the higher wage may lead to an increase in supply, which in turn, lowers the wage. Increased wages might entice other workers to undertake the necessary training. The economic rent that is earned during the period before supply can be increased is referred to as quasi rent. True economic rent refers to the remuneration of factors that are fixed in supply.

Read more at: elearn Economics – https://www.elearneconomics.com/