Who's running things in Michoacan?

In the wee hours of Sunday morning, armed groups bombed and attacked 18 installations of the Federal Electricity Commission (CFE), including 8 substations, and set 6 gasoline stations and a convenience store on fire in Michoacan. Twelve of the state's 113 municipalities lost electricity.

Were the attacks, which appear to have been coordinated, the work of narcos fighting for control of territory? Of terrorists with an ideological agenda opposed to the government? Is the presence of the self-defense groups that started to pop up earlier this year related in any way? Are the attacks related to the three grenades thrown at marchers in Saturday's demonstration by self-defense groups in Apatzingan?

Serious health issues forced Michoacan's elected governor, Fausto Vallejo, to take a six-month medical leave of absence. Politicians in Mexico City believe that the tenure of the interim governor, Jesus Reyna, was a disaster. Mr. Vallejo announced last Wednesday that he was returning to office. Are the attacks related to his return?

Ten days after donning the sash of office in 2006, President Felipe Calderon sent 6,500 soldiers into Michoacan. The controversial decision to send the army into the state marked a watershed in the war against drugs, signaling that the challenge was too much for some state governments to handle on their own. Since then, violence ebbs and flows but never stops.

The weekend's molotov cocktails and the rise of the self-defense groups, some of which seem to be affiliated with different narcos, leave no doubt that the government has not yet been able to regain control of some areas of the state even with the intervention of the army. Let's hope that changes quickly.

The bloom is off the rose: not a fiscal reform dear to businesspeople

The income law passed at the end of last week by Mexico's Chamber of Deputies soured the business community's perceptions of the Peña Administration. Instead of a fiscal reform, the feeling is that the country got another "miscelanea fiscal", an assortment of measures designed to increase the government's tax take by going back to the same taxpayers as always.

There's a real concern that the new tax law will encourage, not discourage, the informal economy. Certainly the elimination of the IETU and the IDE control taxes (the former is effectively an alternative minimum tax and the latter, a tax on cash deposits over a certain monthly amount) takes away two important "sticks" in Hacienda's efforts to ensure, respectively, that all firms pay taxes and to rein in the informal economy. Time will tell whether the incentives the new law contains are sufficient to entice businesses operating informally to become formal. Unless we can see individual companies' tax returns, we'll never know if the elimination of the IETU redistributes the tax burden amongst companies or if those firms that have been paying IETU pay as much or more in income taxes going forward.

Even with an additional 1.0% of GDP in additional revenue next year, the "deficit creep" Mexico has experienced will accelerate sharply in 2014. The expanded social programs that are part of the 2014 budget raise the specter of new life being infused into the patron-client politics at which the "old PRI" excelled.

Meanwhile, it looks like the Administration is betting on public sector spending and exports to propel growth next year. The bet that the passage of President Peña's reform agenda would spur physical investment by private sector is not likely to pay off in 2014, unless it's investments in the energy sector. Portfolio investment is another story, of course: those flows will hinge on the Fed's tapering policy.

A government again...

The US Senate cobbled together a last minute deal to reopen the government and raise the debt ceiling last night, narrowly averting a default by the US Government. The yield on the one-month Treasury bill  plunged from 32 basis points (hundredths of a percentage point) on Tuesday to 14 basis points on Wednesday when a deal looked likely. Today, with the deal inked, the yield dropped to 1 basis point, its typical level prior to the latest edition of the budget/debt ceiling crisis.

The deal bought time. It is not a solution. Unless congressional committees have better luck negotiating budget packages than they've had in the past, we'll suffer a replay of what we've just been through early next year. It doesn't bode well for spending in the holiday season.

Here in Mexico the Chamber of Deputies approved the income half of the budget. The PRI found the votes it needed to pass its tax proposals with votes from the PRD.  It's not coincidental that a few days before the vote the federal government announced the creation of a special fund for the PRD-controlled capital city. The business community is not happy with the "tax reform", which increases the cost of being part of the formal economy.

The cost of shutting down the US government...

If you're in the tourism business or a small company for which the US government is an important client, you've felt the impact of shutting down the US government very directly. That the Congress has chosen to fund particular programs, program by program, leaves no doubt that the constituents served by those programs have made their voices and business cases heard. Unfortunately, if we have to rely on program by program approval to get a budget, we'll still be working on the 2014 fiscal year budget when the 2015 and 2016 budgets come along.

This is not the first occasion on which the US hasn't had a budget when the fiscal year began on October 1. It's happened twelve times since the 1970's. The average shutdown lasted 6-7 working days, according to research by Rabobank and the median reduction in growth during the quarter in which the government was shutdown was 0.9 percentage points of GDP. The last shutdown, during the Clinton Administration, was the longest, lasting 21 working days. We're already at eleven.

This time, the US is hitting the debt ceiling at the same time as the shutdown. The fallout from not raising the debt ceiling is much, much more serious than shutting down the government. If Congress doesn't raise the debt ceiling, authorizing the Treasury to pay for expenditures Congress already approved, default will be the outcome. When Treasury will run out of cash to pay all obligations falling due depends on how much more juggling of revenues and outflows Treasury's money managers can squeeze out of the system. But, that day is nearly upon us: Thursday in the worst of cases, the end of the month in the best.

Please, Speaker Boehner, call a vote. Save us from finding out whether default would be as devastating for the economy and financial system as the Lehman Brothers default in September 2008 was.

Markets focus on the US...

The US fiscal year runs from October 1 - September 30. Hours before the fiscal year is to end, the country still doesn't have a budget.

Tomorrow, October 1, parts of the US Government will shut down unless Congress approves a continuing resolution by midnight tonight. That could happen but, if it doesn't, it wouldn't be the first time the US has begun the fiscal year without a budget in place. We've danced this dance 18 times since 1977. The average shutdown last 6.5 days. The last shutdown took place nearly 18 years ago during the Clinton Administration. The longest ever, it lasted 21 days.

What's the impact of a government shutdown on the economy? Historical experience tells us the median reduction in the growth rate during the quarter the government was shutdown was 0.9 percentage points. That's rather significant in a year when the economy is expected to grow 1.6%. Naturally, the duration and implementation of the shutdown will influence how deep the hit to growth will be.

This time around, the shutdown is the least of markets' worries. Following hard on the heels of the looming shutdown is the prospect that the US may default on its debt payments. The last time it looked like Congress would not raise the debt ceiling - in August of 2011 - the US lost its AAA debt rating.

The shutdown and the debt ceiling are two discrete events. It's especially unfortunate that the two votes are happening so close together. The shutdown is what will happen if Congress doesn't approve a budget for fiscal year 2014. The vote to raise the debt ceiling is, effectively, voting to pay for what you've bought. By voting to raise the debt ceiling, Congress is authorizing the Treasury to borrow the money to pay for expenditures Congress has already authorized.

When Congress votes on the debt ceiling depends on when the US government exhausts its authorized borrowing capacity. This year, Treasury estimated that date to be October 15. However, juggling payments could win a few extra days or weeks.

Markets can live with a government shutdown. The real concern is whether Congress will raise the debt ceiling. If it doesn't and the Administration doesn't find a way to pay its bills, the US Government will default on its debt. No one wants to find out what the impact on the markets would be if the "full faith and credit" of the US Government were questioned.

Mexican migration to the US...

The Pew Hispanic Center estimates that 11.7 million unauthorized immigrants lived in the US in 2012, just over half of whom are Mexican. That's half a million fewer people than in 2007, the year before the "Great Recession" began, and the same estimate as for 2008. Although the number dropped to a low of 11.3 million in 2009, the increases in subsequent years aren't statistically significant. However, it does look like immigration is beginning to pick up.

A couple of points worth making....

1) Unauthorized immigrants accounted for 28% of the immigrant population in the US in 2012.

2) While the largest number of unauthorized immigrants -- 52% of the total -- were from Mexico in 2012, there have been some significant changes in that pattern.
     a) The unauthorized Mexican immigrant population was estimated at 6.0 million in 2012, well below 2007's peak of 6.9 million.
     b) That's not the case for unauthorized immigrants from other countries, estimated at 5.65 million in 2012 compared to 5.25 million in 2007.
     c) Annual apprehensions of Mexicans peaked at 1.64 million in fiscal year 2000. In fiscal year 2012, annual apprehensions were down to 266 thousand.

How do tax burdens compare?

Ever wonder how the direct tax income collected by the Mexican central government compares to what's collected in Brazil, Chile and Colombia? If you did, here's the answer for 2011, stated as a percentage of GDP.

• Mexico:     5.4%
• Brazil:       9.2%
• Chile         7.6%
• Colombia   6.9%

If you include direct taxes collected by all levels of government, the order remains the same:

• Mexico      6.0%
• Brazil       10.5%
• Chile          8.2%
• Colombia   7.5%

What's especially interesting is how direct taxes paid by individuals and companies (as a percentage of GDP) compares in Mexico, Brazil and Chile. (Colombia doesn't provide the breakdown.) Remember: these percentages of GDP are from 2011. If approved, Mexico's proposed fiscal reform will increase the percentage paid by individuals.

Companies

• Mexico   2.4%
• Brazil     3.7%
• Chile      3.9%

Individuals

• Mexico    2.7%
• Brazil      0.5%
• Chile       1.4%