The cost of crime...

What does crime cost Mexico's businesses? According to a new survey published today by the INEGI, Mexico's statistical institute, insecurity and crime cost Mexico's businesses the equivalent of 0.75% of GDP last year. Nearly nine out of ten businesses that were victims of crime did NOT turn to the justice system: 88.1% of businesses did not report the crime or did not initiate an averiguacion previa. Nearly four of ten businesses (37.4%) reported that they were victims of crime in 2011. Three of four reported that they felt insecure. 

A record year for direct foreign investment?

It depends on the regulatory authorities who must approve AB InBev's acquisition of the half of Grupo Modelo it doesn't yet own. The US$20.1 billion acquisition was announced at the end of last June. It still hasn't happened and won't until the regulators sign off on it.

When and if they do, Mexico should post its highest ever direct foreign investment (DFI) figure. It's looking very unlikely that it will be in 2012. Through September, DFI was US$13.05 billion. Without the InBev acquisition, this year's DFI will be modest.

Looks like we'll have to wait until 2013 for a blockbuster DFI number.

Public employment in Mexico's states...

INEGI just published information on public employment in Mexico's states in 2011. Of the 1,678,528 people employed in administrative jobs in the states, 22 states each employed less than 3% of the total. The biggest employer was Mexico City, with  14.3% of the total, followed by Veracruz (11.5%). The states of Mexico, Chiapas and Jalisco employed 7.5%, 7.1% and 7.1%, respectively. The remaining five states employed 3.3% - 5.9% of the total.

For details, see: http://www.inegi.org.mx/inegi/contenidos/espanol/prensa/Boletines/Boletin/Comunicados/Especiales/2012/diciembre/comunica2.pdf

Portfolio investment keeps pouring in...

Mexico's third quarter balance of payments statistics report that foreigners continued to pour money into Mexican financial instruments. Of the US$15.26 billion foreigners invested, almost all (US$14.04 billion) went into peso-denominated money market obligations; equities were the home of the remaining US$1.22 billion.

In the first nine months of this year, foreigners invested US$33.65 billion in money market obligations and US$4.01 billion in Mexican equities. To put the numbers in perspective, portfolio investment in the first nine months of 2012 was greater than foreign direct investment has ever been in any single year. Between January and September of this year, portfolio investment was 6.5% more than crude oil export revenues.

If there had been no portfolio investment this year, there wouldn't have been a capital account surplus. If that money were to flee abruptly....

US government debt & the fiscal cliff: some facts

Federal debt held by the public is now over 70% of US GDP. That's the highest percentage since 1950.

If the US goes over the fiscal cliff, the Congressional Budget Office (CBO) projects the annual deficit will drop from the $1.1 trillion registered in FY2012 to about $200 billion in FY2022. That would bring the deficit held by the public down to 58% of GDP.

Under the CBO's "alternative scenario", the Bush tax cuts would be extended, the alternative minimum tax and Medicare payments to physicians would be, respectively, adjusted and waived, and the automatic spending cuts mandated by the 2011 Budget Control Act wouldn't be made. In the "alternative scenario", the deficit is projected to average 5% of GDP a year over the decade. The debt to GDP ratio is projected to hit 90% of GDP in 2022 and to continue rising.

The FY2013 budget builds in the fiscal cliff. If it is approved as proposed, the CBO projects the deficit will fall to 4.0% of GDP this year (from 7.3% in FY2012) and 2.4% in FY2014. The downside is that GDP would contract 0.5% and unemployment rise to 9.1% in 2013.

Energy independence for the US by 2030...

The US will replace Saudi Arabia as the world's largest oil producer by 2017 and supplant Russia as the world's largest producer of natural gas in 2015, according to the International Energy Agency (IEA). By 2030, the IEA expects the US to be a net oil exporter.

New techniques for extracting oil and gas from shale like hydraulic fracturing and horizontal drilling have boosted US production. Increased production is part, but not all, of the story. The IEA's chief economist gives higher production 55% of the credit for the US move to self-sufficiency. Nearly half (45%) of the credit he attributes to improving energy efficiency. For more, see the following article:

http://www.nytimes.com/2012/11/13/business/energy-environment/report-sees-us-as-top-oil-producer-in-5-years.html?ref=business

A recession in the US next year?

Re-elected yesterday, President Obama now must work with Congress to steer the economy away from the fiscal cliff it's set to fall off of on January 1. The chair of the House Budget Committee will be a key player in the negotiations. Republican Vice-Presidential candidate Paul Ryan is expected to resume that position in the next Congress. The clash of visions will continue. Will there be a willingness to compromise? If not, the US will fall back into recession next year.

Cutting the US deficit...

Here's a link to an interactive calculator from the Washington Post that lets you see the impact of different changes to the tax code. The calculator is a fun, easy way to see where the savings might be found to offset the US$480 billion in lost revenue from the tax cuts Mr. Romney proposes.

Don't be put off by the title ("Make Mitt Romney's tax plan add up!"). We're promised a similar calculator for the Obama proposals tomorrow.

http://www.washingtonpost.com/blogs/ezra-klein/wp/2012/10/31/interactive-make-mitt-romneys-tax-plan-add-up/?wpisrc=nl_pmpolitics

Mexican Reference Rate stays at 4.50%

but the odds have just increased that the next time the Board of Governors moves the rate, it will raise it. In the concluding paragraph of today's monetary policy communique, Banco de Mexico's Board explicitly stated that they will raise the rate, if necessary, to anchor inflationary expectations and stay on track to achieving 3% inflation.

The trigger for a rate increase: if "los choques a la inflacion" (like the ones we've experienced in recent months from agricultural prices) persist, even if they are temporary, and the downward trend in inflation isn't solid.

The Fed stands still and so will Mexico...

At the conclusion of its meeting today, the Fed kept policy where it was before the Open Market Committee sat down on Tuesday.

What does it mean for Mexico? Don't look for any change in interest rate policy soon. Banco de Mexico should keep the Mexican Reference Rate at 4.50% when it meets this Friday.

The Mexican Reference Rate made its debut on January 21, 2008. It's stood at 4.50% since July 17, 2009. 

How do Mexicans rate the quality of government services?

INEGI, the autonomous government entity charged with compiling statistics on Mexico, published the results of a new survey today. The survey asked Mexicans 18 or older living in cities with more than 100,000 inhabitants to rate the quality of 31 tramites (procedures) and government services on a scale of 1 (least satisfied) to 10 (most satisfied). There were some interesting results.

--Nearly half (49.2%) of respondents faced some sort of problem when doing a tramite. In over three-quarters (77.1%) of the cases, respondents cited "barriers to effecting the tramite" as their most frequent problem. Such barriers included "excessive requisites", long lines, being sent from one place to another, and being required to go to places that were far away.

--Three-quarters of respondents said they were "satisfied" with the time it took to comply with the tramite or the service. Four out of five thought they were treated "adequately". Interesting to try squaring those findings with the conclusion above, isn't it?

--Only one in four respondents used the "electronic government" (banks, supermarkets, internet or modulos automaticos). Three out of four went to a government office or the Treasury.

--Respondents were happy with the quality of public services provided by the states, municipalities and delegations: 67.2% thought state-provided services were "good"; 67.0% said the same of services provided by municipalities and delegations. Fewer respondents -- 58.7% -- felt that way about public services provided by the federal government.

--Judging by the average rating of 8.1, respondents are reasonably happy with the quality of tramites and public service. That is more true of some tramites and services than others: signing up for university and the public schools and paying light and water bills received grades of 8.4 - 8.5. Respondents felt differently about tramites in the judicial system (6.1) and ministerio publico (5.9 for the public prosecutor's office) and requesting public services like lighting or paving streets (6.0).

--Respondents were happiest with the quality of such public services as electricity (85.2% described it as good or very good) and water (76.3%). The quality of streets and of police were at the other end of the scale -- 61.6% of respondents rated them bad or very bad.

Small businesses in the US...

Here are some statistics on small businesses in the US from the Joint Committee on Taxation (JCT), a nonpartisan congressional entity.

The conclusion: The Obama proposal to let the Bush-era tax cuts on wealthy individuals (families and individuals making, respectively, more than $250,000 and $200,000/year) would affect only 3% of all small businesses paying taxes -- about 750,000 taxpayers. The 3% accounted for half the estimated $1 trillion in business income reported in 2011.

In testimony to the House of Representatives, the Director of the Urban-Brookings Tax Policy Center stated that 0.3% of S corporations had receipts of $50 million or more. That 0.3% of S corporations accounted for 34.0% of receipts and 26.8% of S corporations' net income. Another 1.7% of S corporations have receipts of $10-50 million. They accounted for a total of S corporations' receipts and 34.0% of net income. In short, 2.0% of S corporations account for 59% of receipts and 60.8% of net income. Only 0.4% of returns filed by S corporations, partnerships and non-farm sole proprietorships were filed by entities that made at least $10 million. They accounted for 59.8% of receipts and 42.0% of net income.

Background: Small companies often take the legal form of a "S corporation", which does not pay taxes. Instead, profits or losses are passed on to the S corporation's shareholders. The tax rate levied on those profits is the individual tax rate rather than the corporate tax rate. Sole proprietorships, partnerships and some limited liability companies are also incorporated as S corporations.

The JCT says that, as of 2005, about 1 in 9 S corporations (11%) were in retail trade, a category that encompasses the "mom and pop" stores. They held 12% of the total assets of S corporations and represented for 5% of partnerships. Those partnerships held less than 1% of assets. About 1 out of 7 (14%) of S corporations were in construction. The largest category of S corporations were in professional, scientific and technical services. The number of tax returns filed by "flow-through entities" has climbed in recent years. 

Wondering what a dollar will cost?

News coming out of Europe has had the peso on a roller coaster. If the ups and downs of the efforts to resolve the European crisis continue to impact the exchange rate, there are several events coming up in Europe this month that could derail the peso's appreciation.

The Euro Group meeting on October 8-9 will be followed by the EU Summit on October 18-19. Bad news coming out of either of these meetings could hurt the peso. Spanish regional elections will be held in Galicia and the Basque country on the 21st. Will they endorse or repudiate Prime Minister Rajoy's economic strategy? Will Spain be forced into a conditionality program to activate the ECB's bond purchase program (OMT) to hold down its borrowing costs?

The underlying economic fundamentals will determine the cost of a dollar over the long-term. In the short-term, what's happening in Europe will too.

How secure do Mexicans feel?

A few of the many results worth noting from the 2012 ENVIPE, INEGI's survey of Mexicans' report of how crime affects them and how secure they feel.

--INEGI, the autonomous statistical institute, estimates that last year 91.6% of crimes committed were not reported or not investigated. In 2010, the figure was 92.0%.
--Three out of five (63.2%) of victims didn't report crimes because they thought the authorities were "deficient": in essence, Mexicans said reporting crimes was a waste of time and nothing would happen.
--Of those crimes that were reported, in three out of five (61.8%) cases Mexicans said nothing happened or the case was not resolved. In 2010, the percentage was 57.9%.

The US "fiscal cliff", in pictures

It's worth clicking on the following link to see several very informative graphics from NPR. They show the composition of the fiscal cliff (US$380 billion in tax increases and US$100 billion in spending cuts) as well as the breakout of the tax increases and spending cuts.

http://www.npr.org/blogs/money/2012/09/19/161427078/the-fiscal-cliff-in-three-and-a-half-graphics?sc=nl&cc=pmb-20120920

Since there are estimates that put the impact of the fiscal cliff as high as 5 points of GDP, it's worth avoiding.

Polling and cel phones...

Whether pollsters include cel phones in their samples or not makes a big difference in the US election. Following are some charts from the 538 column of the New York Times that show the percentage of the vote received by the incumbent and by the challenger in polls of landline and of cel phone users. If only cel phone users are polled, a close race becomes a clear cut victory for the incumbent.

http://fivethirtyeight.blogs.nytimes.com/2012/09/19/obamas-lead-looks-stronger-in-polls-that-include-cellphones/

George Soros on the Euro mess...

Here's the link to the article we talked about in Economex last week.

http://www.nybooks.com/articles/archives/2012/sep/27/tragedy-european-union-and-how-resolve-it/

Greed and fear...

Greed and fear are often said to be the two factors driving the markets. CNN Money has developed an index to measure where on the fear-greed continuum the market is on any given day. For the last month, the market has been in "extreme greed" mode. Here's the link, if you'd like to take a look.

http://money.cnn.com/data/fear-and-greed/

The European Central Bank

The European Central Bank (ECB) followed the Fed's September 13 announcement with its own the next day. Last Friday, the ECB announced the OMT (Outright Monetary Transactions). OMT is the successor to the ECB's SMP and LTRO programs, which also aimed to bring down interest rates on sovereigns under attack. (The SMP is the Securities Market Program, introduced in May 2010 and, as of September 6, subsumed into OMT. LTRO is the Long-Term Refinancing Operation the ECB introduced last December.)

OMT, like the SMP and LTRO, breaks new ground, giving the ECB ever more importance as the institution that can act immediately to save the Euro. What's makes the OMT different from its predecessors?
    First, the only monetary limit on the ECB's purchases of countries' secondary market debt is the amount outstanding that matures within three years. There's no upper limit on the ECB's purchases otherwise. The ECB will buy debt with maturities of up to three years, including longer-term debt with three years (or less) of life remaining.
    Second, the ECB will not have preferred creditor status. The debt it purchases will receive pari-passu treatment with private creditors. That's an earthshaking change: if there are losses, the ECB will share them along with other creditors, a first.
     Third, the ECB will buy countries' debt in the secondary markets only on the condition that the country has a "precautionary program" or a "macro-economic adjustment program" in place. Either program must be negotiated with the ESM/ESFS, which will look to the IMF (International Monetary Fund, up till now the world's creator and enforcer of macro-economic adjustment programs) for guidance. (Yes, more letters... The ESM is the European Stabilization Mechanism. The ESM was to replace the ESFS (European Financial Stability Facility) on July 1. However, until the German courts ruled on the constitutional challenge to Germany's participation in the ESM, the ESM could not be born. On September 12, the German court ruled that Germany's contribution to the ESM is constitutional -- up to the €190 billion agreed. (That is 37% of the ESM's funding.) The German Parliament must approve any future contributions.)
     Fourth, governments must request assistance and the ECB can stop the program (in theory, at least). Spain has been reluctant to ask for assistance even though it was announced in June that Spain would request and receive up to €100 billion in assistance to deal with its banking sector rescue.
     Fifth, the OMT was not launched with the unanimous consent of the ECB's members. The Bundesbank dissented, but the program was adopted anyhow. It would seem that Mrs. Merkel and the Bundesbank don't march in lockstep.

The ECB and Fed took dramatic steps last Thursday and Friday. Crisis has fostered central banks' creativity: to contain crises, central banks are inventing new monetary policy instruments. Time will tell how well they work, in the short and the long-term.

Central banks to the rescue...

Last Thursday and Friday, respectively, the Fed and the European Central Bank (ECB) rode to the rescue: stock prices climbed on the heels of their announcements and investors heaved a sigh of relief as the banks' actions hold out hope that disaster can be averted.

First, the Fed...

What was new in the Fed's statement following its Open Market Committee meeting? The announcement of its third QE program and, especially, the open-ended time commitment of QE3 and the explicit linkage of QE3 to unemployment. The Fed began purchasing (mortgage backed securities (MBS) the next day, September 14. The Fed plans to purchase US$40 billion a month for as long as it takes "if the outlook for the labor market does not improve substantially". Between QE3 and Operation Twist, the Fed will increase its holdings of longer-term securities by about US$85 billion a month through year-end. Operation Twist (the replacement of short-term Treasuries with longer-term ones) expires at the end of 2012.

It wasn't so surprising that the Fed said it would leave the Fed Funds rate where it is (0% - 1/4%) for another year (until mid-2015). But it was an indication of how concerned the Fed is about unemployment that it added that the rate will "remain appropriate for a considerable time after the economic recovery strengthens". In other words, growth alone won't be enough to convince the Fed to raise rates.

The Fed also left the door open to further actions. Additional asset purchases were specifically mentioned. The most traditional of the "other policies" of which the Fed might be thinking would be extending the interest rate pledge. The Fed might also consider some more novel approaches. The ECB has demonstrated that cutting the interest rate on banks' excess reserves to zero doesn't disrupt the financial system. The Bank of England (Great Britain's central bank) has instituted a "funding for lending" program, which attempts to ensure that banks receiving additional funding from the central bank lend the money, not sit on it. Depending on how well the program works, it's something the Fed might consider.





  

After the conventions...

US presidential candidates usually see a "post-convention bounce" in the polls. Following the Republican convention in Tampa, Governor Romney's percentage of the vote edged up 2-3 percentage points, less than usual post-convention bounce.

In contrast, the Democrats' convention in Charlotte produced a substantial uptick for President Obama. Extrapolating from the post-convention tracking polls two days after former President Clinton's masterful political speech suggests Obama's post-convention bounce may be 8 percentage points. (Tracking polls are done over a period of time. In the tracking polls available to date, only some of the people polled responded after the speech. Thus, the need for extrapolation.)

A clarification: I'm not editoralizing or passing judgment on the content of Clinton's speech. Immediately following the speech a Republican television commentator said he wished the Republicans had someone who could give a speech like that. Can't imagine a stronger endorsement of just how good a speech it was in terms of rallying the faithful and attracting voters.

It's electoral college votes that matter. Unfortunately, we don't know how much of a bounce each candidate got from voters in the states up for grabs. According to polling data, voters in Colorado, Florida, Iowa, Nevada, New Hampshire, Ohio and Wisconsin will decide the election.

Reform: in the next two months?

President Calderon has thrown down the gauntlet, so to speak. Will the PRI and PAN work together to pass the two important pieces of legislation -- labor reform and modifications to an existing law that would extend its transparency and accountability provisions -- the President has sent to Congress? Under a "governability law" approved recently, Congress has two months to act on these proposals.

If Congress approves the reforms, the Calderon Administration can take the credit. Will the PRI get started now or will the party prefer to wait until Mr. Peña takes office to begin the reform process? 

Portfolio investment: not what it was

More on Mexico's capital account deficit in the second quarter...

Portfolio investment continued flowing into Mexico in the second quarter, just  not in the massive quantities of prior quarters. The second quarter's US$6.56 billion in portfolio investment was the fifth largest quarterly inflow of portfolio investment in Mexico’s history. Nonetheless, it was just over two-fifths (41.4%) of the portfolio investment in the first quarter of 2012. Foreign investment in Mexican stocks (US$0.91 billion) was less than half what it was in the first quarter. The US$5.65 billion of foreign investment in fixed income instruments was two-fifths of its first quarter level.

Had portfolio investment arrived in its first quarter quantities, Mexico's capital account would have shown a good-sized surplus in the second quarter...

A big jump in Mexican deposits in foreign bank accounts in the second quarter..

Mexico posted a small US$1.84 billion capital account deficit in the second quarter, a sharp contrast to the first quarter's record US$24.68 billion first quarter surplus. A big piece of the explanation lies in the movements in the "assets held abroad" account.

Assets held abroad rose US$24.32 billion in the second quarter; in the first, they declined US$1.78 billion. Mexican foreign direct investment is one component of "assets held abroad". It was slightly higher in the second quarter than in the first (US$6.50 billion compared to US$5.00 billion). The big change was in deposits held in foreign bank accounts. In the first quarter, Mexicans repatriated US$6.66 billion. In the second quarter, they diversified the currencies in which they held their assets, sending US$17.18 billion to foreign bank accounts.

What's a fiscal cliff and is the US about to fall off it?

US growth will drop next year if Congress and the President can't come to an agreement to steer away from the "fiscal cliff". Politics will decide if the US goes off the cliff or avoids it.

Last summer, Congress's delay in raising the US debt ceiling cost the country its AAA rating. The compromise that finally got the higher debt ceiling approved created the fiscal cliff that's now looming.

In a nutshell, the fiscal cliff (which could also be thought of as the triple witching hour) is what will happen to the economy when the tax cuts in the $747 billion stimulus package run out, some or all of the Bush tax cuts are allowed to expire, and the automatic cuts to federal expenditures beginning in 2013 Congress approved late last year take effect.

Estimates put the impact of the cliff at 5 points of GDP. Ouch...

Fixing LIBOR...

Barclays Bank is in the spotlight for submitting its LIBOR fixes to benefit its trading positions. It's not the only major bank to have engaged in the practice. Investigations should soon result in charges being filed against other "too big to fail" banks. Institutions that have said they are being investigated include Citi, JP Morgan Chase, Royal Bank of Scotland, UBS, and Credit Suisse.

The scandal underscores that trading has replaced lending as the lifeblood of banking. The nature of the bank-client relationship has changed. Clients have become counterparties, which translates into "buyer beware". Financial institutions don't have the same fiduciary responsibility to counterparties as they do to customers.

Who takes the losses that offset the traders' gains from manipulating LIBOR? Counterparties to the trades did. Some  can be considered sophisticated investors. Several hedge funds and some traders have filed suit on contracts traded through the Chicago Mercantile Exchange. Charles Schwab filed a complaint in 2010.

Others, like cities, relied on the advice of their bankers. Some US cities are suing to recover the losses that artificially low LIBOR rates would have caused. Here's an example of how it works. A city enters into an interest rate swaps based on LIBOR. The bank pays its municipal counterparty a variable payment based on LIBOR. The city pays the bank a fixed payment. If LIBOR is artificially low (because of rate fixing), the city receives a smaller payment. Nassau County's comptroller estimates that the county may have lost US$13 million (on swaps on outstanding bonds with a face value of $600 million) because of rate fixing.

The suits will be very difficult to win. But, banks that are suspected of fixing rates can expect to spend "tens of billions of dollars" on lawsuits, according to a professor at Stanford University.

More importantly, the trust indispensable to well-functioning markets will be further undermined.

Anything worth mentioning about the election results?

As anticipated, Mexicans returned the presidency to the PRI on July 1. Enrique Peña Nieto, the nominee of the PRI and the Green Party, sailed to victory over the PRD and PAN candidates: with 95% of votes counted, Peña won 38.1% to AMLO’s 31.7% and Vasquez Mota’s 25.4%.

What’s worth mentioning about the results? For one, Peña’s margin was much smaller than the daily polls published by El Universal newspaper in conjunction with the reputable survey firm GEA-ISA projected. The final poll before the elections gave Peña 46.9% of the vote, 9.2 percentage points more than he actually received. The 14-16 percentage point margin Peña enjoyed in the polls earlier in the campaign eroded to just 6.3 points on July 1. So, although Peña won comfortably, his victory wasn’t the landslide that had been anticipated.

Neither did the PRI win control of Congress. Although the PRI and its coalition partner, the Green Party will hold more seats than any other party or coalition on both chambers of Congress, they will not hold a majority in either house.

Including the seats won by its Green allies, the PRI-Green’s 232 seats fell well short of the 251 seats required for an absolute majority in the Chamber of Deputies. In fact, the coalition won fewer seats than the 239 the PRI alone held in the previous legislature. The two parties’ seat total fell by 30. The 2014 election could give Mr. Peña an absolute majority in the Chamber of Deputies but, for the next two years, he will have to look for the votes he needs to pass legislation from other parties. Even if Peña can bring along all ten of the Panal’s deputies, he will still have to get some of the votes he needs for a majority from the PAN or the PRD.

In the Senate, the PRI-Green alliance did better. They are expected to win 57 of the chamber’s 128 seats, 16 more than in the previous legislature. Unlike the US where a third of the Senate is elected every two years, in Mexico all senators’ terms run the same six years as the presidential sexenio. The July 1 voting means that unless the new president can persuade some senators to change parties, he will never have a majority in the Senate. And, the senators whose votes he needs will have to come from the PRD or PAN.

Voters left no doubt they are disillusioned with the PAN. Their presidential candidate, who garnered only a quarter of the vote, was almost as far behind the second place AMLO as AMLO was behind Peña. In the Chamber, the PAN also finished third, behind the PRD and its Worker Party (PT) and Citizens’ Movement (Movimiento Ciudano) allies.  The PAN is expected to end up with 118 seats, 24 less than in the prior legislature. The PAN is expected to be the second largest party in the Senate. Its expected 41 seats will be nine fewer than before.

Although AMLO lost by a much larger margin than his razor thin 2006 loss, the PRD and its allies picked up a hefty 52 more seats in the Chamber of Deputies. Their expected 140 seats will make the left the second largest grouping in the Chamber for the next two years. The party’s gains came at the expense of the PAN and PRI-Greens, which dropped 24 and 30 seats, respectively. The PRD-PT-Citizens’ Movement coalition lost four seats in the Senate. With just 29 seats, the left will be a distant third force in the Senate.

Foreign direct investment will soar in 2012...

Foreign direct investment (FDI) just went through the roof. InBev's announcement that it will pay US$20.1 billion to assume control of Grupo Modelo could well put this year's FDI above the 2007 record of US$31.3 billion. No need to worry about 2012's capital account surplus -- unless portfolio investors were to abruptly liquidate their holdings of money market obligations.

Remember: although the US$20.1 billion InBev will pay Modelo's shareholders counts as FDI, it does not mean that money will swell the supply of dollars for sale in the exchange markets which, all other things being equal, would strengthen the peso. Watch for the effects of this transaction in the capital accounts in the balance of payments the rest of this year.

The evidence on supply side economics...

The Institute on Taxation and Economic Policy looked at growth rates in states with and without an income tax. The conclusion: per capita growth in the nine "high tax states" between 2001 and 2010 was higher than in the nine "no tax states" and than in the 50 state sample.

The numbers: average increase in per capita economic output, 2001 - 2010

50 states                   8.1%
9 "no tax" states        8.7%
9 "high tax" states   10.1%

Change in median household income, 2001 - 2010

"no tax" states       -3.5%
"high tax" states    +0.7%

For more, see http://www.itepnet.org/pdf/junkeconomics.pdf

Pass through...

For many years when the peso devalued, inflation rose. Theoretically, only the price of "tradable goods" should rise with a devaluation. In practice, in Mexico, all prices increased. One of the major accomplishments of the macro-economic stability forged over the course of the last 25 years is that the link between devaluation and inflation, the "pass through" effect, was broken.

In the 2009 crisis, the average fix exchange rate devalued 17.5%. Notwithstanding that, inflation fell from 6.5% in 2008 to 3.6% in 2009. It's a striking contrast to 1995. That year, the average annual fix exchange rate devalued 45.1%. Inflation soared, climbing from 7.1% in 1994 to 51.2% in 1995.

That the pass through is no longer automatic doesn't mean that it no longer happens. The average monthly fix exchange rate devalued 9.6% between March and June 1-22. The inflation figures for the first half of June show that the devaluation is finally hitting price levels. In the first two weeks of this month, merchandise prices (the component of inflation in which the impact of a weaker peso shows up first) rose 0.26%, more than the overall inflation rate. In 15 days, merchandise prices rose by nearly as much as they did, on average, in each of the prior three months. If the peso doesn't revalue, inflation could exceed 4% this year.

The finances of US households...

The Fed's portrait of the "median family's" finances in 2010 has some sobering figures. Things got worse, not better for American families between 2007 and 2010.

INCOME AND NET WORTH: Median family earnings in the US dropped 7.7% between 2007 and 2010. Median family net worth (half of families' net worth was higher and half, lower) came in at $77,300 in 2010. The housing crash explains 3/4 of the drop from 2007's $126,400 median net worth. The median amount of home equity fell to $75,000 in 2010 (from $110,000 in 2007).

SAVINGS & DEBT: The percentage of families who saved during the year fell from 56.4% in 2007 to 52% in 2010. Since total savings have risen, it means that a smaller group of families is saving more. Nearly three-quarters (74.9%) of families still had debt in 2010. The median amount of debt in 2010 was the same as in 2007. So much for the success of households in deleveraging... The percentage of families without credit cards rose from 27% in 2007 to 32% in 2010. The percentage of families with credit card debt fell to 39.4% (from 46.1%). The median balance dropped 16.1%, to $2,600.

Spain succumbs

As much as he tried to avoid it, Spain's Prime Minister Rajoy had to ask for a rescue package. While the symptoms of Spain's woes -- high funding costs, contraction and soaring unemployment -- are similar to those of Greece, their causes are different. Greece shows the "sovereign" face of the European crisis. Spain reveals the "financial" visage.

Spain's rescue will be channeled through its banking rescue fund to confront the consequences of a real estate bubble. Although the Spanish government's debt to GDP ratio is high now, it wasn't before the crisis. The Spanish central government's finances were in order. Recession and soaring borrowing costs were the culprits for the sudden deterioration of the central government's finances.

Of course, the pre-crisis housing and construction boom contributed to the health of Spain's finances. We now see -- as we did in the US -- how the extension of loans that couldn't be repaid contributed to the boom. How much the bursting of the real estate bubble will cost Spanish taxpayers remains to be seen. How much of the up to €125 billion in funding will be extended will depend on the conclusions of the two audits due out June 21.

Chicken?

The European situation is as tense as it was last fall -- or worse. This time, though, the European Central Bank (ECB) didn't come to the rescue. Last December, the ECB opened the funding doors to European banks, a move that temporarily defused the crisis. At the conclusion of today's meeting, the ECB didn't make any dramatic announcements. The high-stakes argument over how money to bail out banks will be channeled -- directly to the banks or through their governments -- hasn't been resolved. The ECB's lack of action puts more pressure on governments to come to a decision.

Which sectors of the US economy are most exposed to Europe?

From the June 4 New York Times, an interesting table on the European sales of US companies in different sectors...

Figures are estimates for 2011 and 2012. *Excluding telecommunications companies and banks because the index only includes regional banks and companies in those sectors whose business is restricted to the United States. †Excluding sales in Canada and the Carribean

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Sources: Company reports; Citigroup Global Markets

Is the hot money still pouring in?

That is the big question. Portfolio investment in unprecedented amounts -- US$13.96 billion -- flooded into Mexico in the first quarter. To put the figure in perspective, portfolio investment in Q1 2012 was 70% more than the combined amount of net debt taken on and foreign direct investment (FDI).


Portfolio investment has been instrumental to the peso’s post-U.S. financial crisis recovery.  Significant and swelling inflows of portfolio investment beginning in Q1 2009 and accelerating through Q1 2012 have supported a strong peso. 


Carry trade opportunities, worldwide liquidity conditions, and Mexico’s market-derived risk rating (the spread on credit default swaps (CDS) converted to an equivalent ratings agency grade) all enhanced the attractiveness of Mexican money market instruments for foreign investors.  In 2010, foreigners poured US$23.13 billion into money market obligations, nearly equal to direct foreign investment in the year.  In 2011, the net inflows came to US$31.65 billion (62.8% more than direct foreign investment). In Q1 2012, the net inflows were US$13.96 billion, more than three times direct foreign investment in the quarter.


Investors haven't been as keen on equities, the other component of portfolio investment. Foreign investment in Mexican equities was just US$0.64 billion in 2010. In 2011, foreigners pulled US$6.25 billion out. In the first three months of 2012, they put US$1.88 billion into Mexican stocks. 

New economic terms...

The Greek crisis is edging closer to tragedy. In the process, it's coined a few new terms. Amongst them are "bank jog" (a slow-motion run on the banks) and "drachmageddon" (the outcome of substituting the drachma for the Euro).


We're in uncharted territory, which makes investors extremely nervous. Markets reflect that. The average fix peso-dollar exchange rate has depreciated 3.1% this month compared to April. 


Where the peso ends the year depends on what happens in Europe. Could it be $14? Yes. It could also be under $13. If you need to buy or sell pesos, timing will be all-important. Watch the markets and the headlines and time your transactions accordingly.

Logistics in Latin America: an expensive proposition

In Latin America, logistics represent about 25% of products' value. In the US, that number is 9.5%. In Singapore, it's a bit over 8%. Ouch...

Europe, again...

The cost of a dollar shot up from $12.96 on the first trading day of May to $13.52 a week later. No matter that the news that Mexico had a US$1.57 billion trade surplus in March (US$1.75 billion in the first quarter) had come out a few days previously.

Resurgent fears over Europe were behind the peso's sudden drop. The results of the French and Greek elections rattled investors. Concern over Spain is rampant.

Although the focus is on government debt as a percentage of GDP, Spain's problem is much more serious. Spanish government debt is "just" 70% of GDP, an almost reasonable percentage compared to Italy's 120% or Greece's 160%. The sum of Spanish banks, households and government debt comes to 363% of GDP, putting Spain third to Japan (512%) and Great Britain (507%).

"The prettiest horse in the glue factory"

The US economy grew at a 2.2% annualized rate in the first quarter, a rate that only looks good in comparison to Europe's economic performance and the double-dip recessions into which Great Britain and Spain have fallen. In the fourth quarter of 2011, US GDP grew 3.0%.

The decline in the growth rate was not across the board. Personal consumption expenditures accelerated, rising 2.9% in Q1 (up from 2.1% in Q4). Government spending continued to contract (-3.9% in Q1) although at a slower rate than in Q4 (-4.2%). Government spending subtracted from GDP for the sixth consecutive quarter; it cut 0.60 percentage points from growth in Q1. A sharp drop-off in the growth rate of investment (from 22.1% in Q4 to 6.0% in Q1) pulled growth down in the first quarter of 2012. Inventories  contributed 1.81 percentage points to growth in Q4; in Q1, they contributed only 0.59 percentage points. Non-residential fixed investment reduced growth by 0.22 percentage points in Q1; in Q4, it added 0.53 percentage points to growth.

An interesting aside... To see how young US voters rank the importance of different issues, see the summary of Harvard University's Institute of Politics' "Survey of Young Americans' Attitudes Towards Politics and Public Service: 21st edition" at the following link: 

http://www.nytimes.com/interactive/2012/04/28/opinion/blow-young-peoples-priorities-chart.html?nl=todaysheadlines&emc=tha212_20120428

The US economy: before and after...

Take a look at a number of key indicators comparing how the US economy looks now compared to before the "Lesser Recession". Some fascinating charts....

http://www.nytimes.com/interactive/2012/03/22/your-money/where-the-comeback-has-and-hasnt-taken-hold.html?nl=your-money&emc=your-moneyemb1_20120423

Cuidad Juarez, as seen from the US...

A review of a documentary on what's happening in Cuidad Juarez, "Murder Capital of the World", from today's New York Times. Here's the link:

http://www.nytimes.com/2012/04/20/movies/murder-capital-of-the-world-a-look-at-ciudad-juarez.html?emc=tnt&tntemail1=y

Borrowing abroad...

In each of the last two years, the Mexican private sector's net foreign borrowing exceeded that of the public sector. Last year, the private sector borrowed (net) US$7.96 billion; the public sector borrowed US$5.63 billion. The private sector's total net foreign borrowing in the last two years totaled US$26.89 billion compared to US$19.30 billion for the public sector. Including the central bank's debt repayment reduces the two year public total to $16.08 billion.

The Mexican election, as seen from New York...

Here's how a New York Times journalist portrays the presidential candidates... For the entire three page article, see the link below the quote.

"Enrique Peña Nieto, the telegenic front-runner sometimes called the Pretty Boy (or Gel Boy because of his styled hair), needs to persuade voters that he represents a new, corruption-free Institutional Revolutionary Party, or P.R.I., the party that ruled Mexico from 1929 to 2000. But can he prove he is not just a handsome meringue atop an old authoritarian party?

Josefina Vázquez Mota, a former education secretary under the current president, has perhaps a greater challenge. She has been called the Quinceañera Doll because she is always smiling, but her party — the P.A.N., orNational Action Party — has been in charge for 12 years, a time of rising violence and continued corruption. Can she convince Mexicans that she represents a break from her party and become the country’s first female president?

And even for Andrés Manuel López Obrador, a liberal former mayor of Mexico City who lost the last election in 2006 by 0.6 percentage points, the past and future compete. The oldest of the candidates, sometimes called the Tired Has-Been, he must answer the question of whether he has put aside the radical populism of his last campaign to govern as a moderate."

http://www.nytimes.com/2012/04/01/world/americas/mexicos-presidential-race-could-be-pivotal.html?src=recg

A Bull Market?

Three years ago stock markets took off. Bull markets usually last less than 4 years. Are we nearing the end of this bull's run? Maybe but, then again, maybe not. Between late April and early October of last year, the S&P 500 lost 19.4%. A market becomes a "bear" when the drop is 20% or more. Measured by closing prices, we didn't have a bear market but if you look at the index during the trading day, last October 3, the S&P 500 dropped more than 20%.

There are some other signs that this year's run-up might be the first year of a new bull market rather than the fourth year of the 2007 bull. One is that shares of technology firms, small companies, and consumer discretionary stocks do best at the beginning of a rally. That's true now. Typically, consumer staples and health care and utilities are leading the market in an aging bull market. That's not the case now.

The biggest gains in a bull market are generally made in the first year of a rally. Since World War II, the gain in the first year of a bull market has averaged 38%. Since October 3, the S&P 500 is up 27%.

If you were ever tempted to think that a bull is a bull, disabuse yourself of the notion. There are different kinds of bull. There are cyclical bull markets and secular bull markets. The former accompanies a single economic expansion. A secular bull market encompasses both bull and bear markets and can last more than a decade. Historically, at the beginning of a secular bull, P/E ratios are in single digits; that's not the case now. The last secular bull market ran from 1982 to 1999.

There are also "non-economic rallies" (NERs). NERs are rallies following a bear market that don't coincide with recessions. The historical record since World War II tells us NERs are shorter and more muted than a bull market. On average, they last 31 months (compared to over 3 years) and the median cumulative return is a bit less than 62% (compared to the nearly 102% median return of a bull market when the economy is coming out of recession).

What kind of bull is this?

Has Brazil got it all worked out?

The subject of Brazil's economic success came up the other morning in Economex. For those interested in following up on the discussion, here's a well-informed, succinct article by Jerry Haar on the Brazilian economy. It appeared in the Latin Business Chronicle.

Tuesday, March 20, 2012

Perspectives

Brazil: A Cautionary Note

The irrational exuberance over Brazil must be tempered by both macroeconomic and operational realities.

BY JERRY HAAR

“Curb Your Enthusiasm” is not just the title of a popular HBO television series but an astute advisory to those engaged in, or contemplating, trade, investment or commerce with Brazil. To be sure, Brazil continues to be the most attractive and “user-friendly” BRIC in which to do business. However, the irrational exuberance displayed by so many (those who have not lived or worked there) must be tempered by both macroeconomic and operational realities.

To begin with, Brazilian economic growth is heading downward. In the fourth quarter of 2011 Brazil’s economy dodged a recessionary bullet. Consumer spending cushioned a continued decline in manufacturing; and despite slowdowns in China and India, the demand for commodities also served so curtail a further slide in the Brazilian economy. Clearly, Brazil is not growing near its full potential, despite rising commodity prices and inflows of foreign direct investment. An overvalued currency has been a boon to importers, Brazilian consumers, services, restaurants, and Brazilian shoppers traveling abroad. (Retailers in Miami, New York, and Los Angeles surely believe now that Deus é um brasileiro…..or brasileira.)  However, the strong real is contributing to what many claim is the de-industrialization of Brazil, as local manufacturers of auto parts, apparel, textiles, and electronics are experiencing a competitiveness meltdown, as cheaper imports—and not just from China—eat into their customer base. The government is attempting to cushion the blow through program such as “Brasil Maior,” which offers a combination of tax cuts, financing, and trade-related measures to level the competitive playing field somewhat.

The good news is that consumers will continue to drive the economy. Firms like Redecard, Telefónica, Cielo, and AmBev have been strong performers.  Additionally, there will be a fairly steady demand for commodities and natural resources. (China especially cannot afford to slow down its economy too much for social and political as well as economic reasons.) Unemployment remains low, wages are increasing and the government is committed to continued credit growth.

Much has been made of the coming oil bonanza along with the World Cup in 2014 and Olympics in 2016—all which will provide a constant flow of revenue and a stream of employment—especially for much-needed infrastructure projects—that will keep Brazil on a growth path. Here, too, however, one must sound a cautionary note. Lower interest rates and fiscal pumping could well end up exacerbating inflation; and will there be enough construction and related jobs after 2016 to allow workers preparing for the World Cup and Olympics to maintain their employment? And what of the public debt incurred to fund these massive sports-related projects?

As for oil reserves, Brazilian deposits below a layer of salt in the Atlantic Ocean hold at least 123 billion barrels of reserves, twice government estimates and equal to that of the North Sea. However, Petrobras financials have deteriorated, and there have been production setbacks and oil spills. Additionally, Brazil’s refining capacity has hit its limit---the country now exports oil to Asia and imports it back as gasoline! For all these reasons, Banco Bradesco has lowered its rating on Petrobras.

Curbing one’s enthusiasm for Brazil does not mean discarding the country as an attractive place for doing business. Despite its challenging business environment (the country ranks 126 out of 183 in the latest World Bank Doing Business report), the assets clearly outweigh the liabilities. The sheer size of the nation with its huge consumer class, abundant natural resources, prudent fiscal and monetary policies, a middle class that now accounts for more than half the population, and a broad array of domestic multinationals and supplier networks with a global reach are compelling reasons to be guardedly optimistic about Brazil. Competitive sectors, such as agriculture and agribusiness, avionics, biopharmaceuticals, and deep-water oil exploration, are driving innovation in the country.

Brazilians have long claimed that their nation is the country of the future. No longer. The future has arrived---but it is one that poses enormous challenges along with huge possibilities. Success can come only to those who proceed with caution.

Jerry Haar is associate dean, professor and director of the Pino Global Entrepreneurship Center in the business school at Florida International University. He is also president of the Business Association of Latin American Studies

The Face of Violence...

It seems to be "Mexico week" in the New York Times. Here's another article, one which puts faces to the concept of impunity.... Even if you live in Mexico City, chances are you haven't seen or heard about this. Take a look at an artistic approach to dealing with crime.

http://www.nytimes.com/2012/03/22/world/americas/mexican-art-project-puts-faces-on-crimes-toll.html?nl=todaysheadlines&emc=tha22_20120322

Mexico in the New York Times...

If you believe it's important to know what's being said abroad, this article is a sad "must read".

http://www.nytimes.com/2012/03/18/world/americas/in-mexico-a-kidnapping-ignored-as-gang-crimes-go-unpunished.html?pagewanted=1&nl=todaysheadlines&emc=tha3_20120318

Job creation in Mexico...

The good news is that employment is rising in Mexico.  The bad news is the quality of the jobs being created.  In 2011, the number of workers registered in the IMSS (the Social Security Institute) rose by 591 thousand, 23.9% of the total jobs created in the economy.  The number of people working in the informal economy grew 1.6 million, nearly two-thirds of the total.  The percentage of people working in the informal economy rose to 29.2% in Q4, the highest percentage of any quarter since the statistical series began in 2000.  The seasonally adjusted underemployment rate hit 9.0% in Q4 2011, its third highest level since the statistical series began.  (It was higher only in Q2 2009 when it was 11.0% and in Q1 2010, when it was 0.02 percentage points higher.)  The increase in the number of “underemployed” workers (835 thousand) was 41.3% greater than the number of jobs — permanent and temporary — registered in the IMSS.    

When does 13.67% for 10-year money look cheap?

When you're Portugal and were paying 18.29% on January 31....

Greece reached a deal with its private sector creditors last Friday but the European saga is far from over. Another restructuring is widely expected. Portugal is a likely candidate, given the interest rates the country is paying for its debt.

Greece is another, although not until next year. The yields on Greece's new bonds (the ones that were restructured last Friday) are running between 14% and 19%, higher than the yield on the country's short-term debt. That's an indicator that markets expect another restructuring down the road. Even with the debt relief, Greece's debt to GDP ratio is projected to be 151% this year, dipping to 149% next year.

The cost of collecting taxes...

According to Hacienda, "During 2011, collecting 1 peso cost 0.94 centavos".

Mexico adopted a floating exchange rate regime in 1995, a consequence of the crisis. In a floating exchange rate regime, if the capital account surplus matches the current account deficit, the currency should be stable.  If the current account deficit exceeds the capital account surplus, the currency should depreciate.  Conversely, if the capital account surplus exceeds the current account deficit, the currency should appreciate.


Over the long-term, the relationships hold true.  On any given day, however, the exchange rate doesn’t necessarily reflect the underlying fundamentals of the economy.  The peso’s abrupt plunge and climb over the last six months certainly doesn’t respond to changes in the underlying fundamentals of the economy.  The fix rate went from a low of $11.57 in July 2011 to $13.95 at year-end to a low of $12.64 in February 2012.  This year alone, between January 2 and February 7, the fix rate dropped from $13.93 to $12.65. 


However, the dynamic driving the current and capital accounts does give some pause. In the former case, it is oil; in the latter, foreign investment in money market obligations. 

And the money just keeps flowing...

The most noteworthy number in the Mexican balance of payments data published this morning was the amount of foreign investment in money market instruments -- US$31.65 billion. It's an historic level, 36.9% more than in 2010, the previous high. Foreign investment in money market obligations was responsible for 3/5 of the year's capital account surplus; it was 63% greater than last year's direct foreign investment. This is money that moves with the click of an "enter" key.

Portfolio investment was in money market instruments, not in Mexican stocks. In 2011, foreigners reduced their equity holdings by US$6.25 billion. Foreign debt accrued at a much slower pace: net indebtedness increased US$13.59 billion in 2011, less than half of the increase in 2010.

Did you know?

Accelerated depreciation and tax credits for R&D represent the bulk of the US government's foregone revenue from tax benefits to companies?

Debt / GDP in selected European countries...

courtesy of the New York Times, February 15, 2012

More tourists visiting Mexico than ever?

Yes and no. By the new definition of total tourists, 1.9% more tourists visited Mexico in 2010. The new definition excludes border tourists who don't spend the night. Using the previous  definition of total tourism, which does include day trippers, the number of visitors in 2011 was 7.3% less than in 2010.

Use of government programs in the US...

Here's a fascinating map of the US, courtesy of the New York Times. The map shows the percentage of personal income coming from government benefits. In 1969, government benefits accounted for 8% of personal income in the US; in 2009, 18%. The breakdown goes as far as the county level.

http://www.nytimes.com/interactive/2012/02/12/us/entitlement-map.html?nl=todaysheadlines&emc=tha2

US exports to Europe, by state...

With Greece and its creditors in ever more difficult negotiations, the map of US exports to Europe by state (developed by Wells Fargo) is an interesting one. US exports to Europe are the equivalent of 2% of US GDP and 22% of total US exports. The fallout from the European crisis is not so much from trade; it's the financial system. Here's the link to the map and some analysis:

https://www.wellsfargo.com/downloads/pdf/com/research/special_reports/States-with-European-Exposure_11142011.pdf

Important dates...

Today, January 30, is an important date in the evolution of the European crisis, now in its third year. Europe's political leaders are meeting to plot their next step.

February is less obvious but no less significant: US banks will release their 2011 financial statements. The US Securities and Exchange Commission's (SEC) "request" that US banks be more forthcoming and consistent in their presentation of their European positions could give a much clearer understanding of their exposure to Europe through credit default swaps (CDS).

Remember: so long as the Greek re-structuring is "voluntary", CDS can't be called. No one knows what the impact of bringing the CDS into play would be on the international financial system and no one wants to take the risk of finding out. It was CDS that brought AIG down in the fall of 2008.

Supply chains: a reminder of vulnerabilities...

PIP and SOPA have dominated the news the last several days but those legislative proposals are not the only IT-related issue that bears mention. Soaring prices for hard drives are a vivid reminder of the vulnerabilities of long distance, geographically concentrated supply chains.

Last year, Thailand from suffered devastating floods. Before the flooding, 40% - 45% of the world's hard disk production was done in Thailand. Attaining pre-flood production levels is taking much longer than expected and consumers are feeling it higher prices: certain models sold in the US cost 40%-50% more than before the flooding.

Companies in a myriad of industries became painfully aware last spring that they were unknowingly exposed to the tsunami in Japan through their supply chains. Perhaps this latest demonstration of how geographically concentrated production can create vulnerabilities will underscore the importance of looking at a wide range of factors when choosing amongst suppliers and investment sites.

Could this be in Mexico's future?

The financial state of Spain's autonomous regions...

"Spain’s highly autonomous regions have spent recklessly in recent years — on generous public services and expensive capital projects, some of which look ridiculous in hindsight. Two regions, for instance, have built large airports, though virtually no one uses them.

And the regions’ failure to pay their creditors is now endangering many small enterprises, which are the backbone of the Spanish economy, already suffering from more than 22 percent unemployment, the highest in Europe.

Despite pressure from Madrid to rein in their budgets, many regions failed to meet their budget goals this year — a huge factor in Spain’s failure to meet its targets."


Remember Coahuila.

http://www.nytimes.com/2012/01/20/world/europe/spanish-regional-governments-to-get-aid.html?nl=todaysheadlines&emc=tha22

Savings and culture...

For those of you who attended Economex this morning, here's the link to the transcript of the interview with Sheldon Garon, author of the book we discussed, "Beyond Our Means: Why America Spends When The World Saves".

If you weren't there, it's worth looking at the book or the following transcript....

Sheldon Garon of Princeton University talks to Romesh Vaitilingam about his book, ‘Beyond Our Means: Why America Spends While the World Saves’. He contrasts continental European and East Asian countries, which have over many decades encouraged their citizens to save, with the US, which has promoted mass consumption and reliance on credit, culminating in the global financial meltdown. The interview was recorded in London in November 2011. [Also read the transcript]

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Find out more about Beyond Our Means: Why America Spends While the World Saves here.

Related article(s):

• US monetary policy and the saving glut

Transcript

Romesh Vaitilingam: Welcome to Vox Talks, a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam, and today's interview is actually with a historian, Professor Sheldon Garon from Princeton University who has written a book called Beyond Our Means: Why America Spends While the World Saves. When we met in London in November 2011, I began by asking him to explain the basic story of his book.

Sheldon Garon: The story is that the United States after 1945 diverged from really what was happening in the rest of the advanced economies of the world. They were all digging out from World War II, whether it was Japan or most European countries, they were all in savings and austerity modes with massive national savings campaigns.

The United States diverged from that, partly because it won the war, it suffered no war damage, it controlled a huge share of the world's production, very prosperous. It certainly didn't having to continue the sort of saving and austerity campaigns that we saw elsewhere. So that was one thing.

Beyond that, after 1945, new political ideas and economic ideas, including Keynesianism, but Keynesianism with an American inflection, led policymakers in both political parties, led the labor unions as well as businessmen, led to a broad consensus on the part of influential Americans that consumption would be the new driver of economic growth. And of course not only consumption, but the credit that was needed to finance consumption.

So consumer credit had already been quite advanced in America before World War II in the 1920s. But in the 1950s, what we call "installment purchases" thrived in America. Also, home mortgages. The buying of homes, and you can consider that also as sort of a consumption, but home ownership was promoted more in the United States at an earlier point that in most countries.

Federal Government policies have really started promoting home ownership as early as the 1930s, at the height of the Great Depression - the New Deal. The U.S. government promoted home ownership in many ways, including federal guarantees of private banks making loans and making 25 to 30 year fixed mortgage loans, which made them very affordable to home owners. And this too, although it started in the 1930s, really boomed after World War II.

So we had a long term, early post war development that didn't necessarily stop people from saving, but it certainly diminished the rate of saving. Not necessarily a bad thing. People borrowed freely to buy things, and they borrowed freely to purchase their homes. And there evolved in the U.S., a certain sort of, you could call it a savings behavior, but it's quite different from the rest of the world. It was a saving through housing.

That you took your surplus assets, and you tended to put them into your house, into your home mortgage, and saw your house, usually in that period, gradually appreciate. Those were kind of long term developments. Then 1980 marks a sort of a turning point. Before that, this credit, this consumption, this home buying seemed to be quite sustainable. People paid back their debts.

After 1980, because of a number of changes, you get the extraordinary availability of credit, both housing and consumer credit. It starts around 1980 with the deregulation of the credit card industry. Before that, credit card companies were really held back from charging much on the balance that people owned on credit cards by various anti usury laws in individual states. It made it very difficult for credit card companies to make much money on their cards. After 1980, credit card companies, because of various deregulatory policies, were able to actually charge whatever the market would bear. So more and more, credit card became a mass commodity in America, but also, more and more, people got over their heads in debt.

Home equity loans, which really hadn't existed much. Second mortgages. And after 1986, as a result of the tax slab, home equity loans just proliferated. Banks found that they were a very easy way to make money. That they could convince people that there were just unbelievable amounts of cash that they could get simply by taking a loan against the increased value of their homes, their equity. Now, this particularly exploded after the early 1990s to 2005, when home prices skyrocketed and Americans simply wrote themselves checks on the basis of these home equity loans, figuring that they could pay it back when their housing prices went up.

We also have sub prime loans made to some of the poorest Americans who probably couldn't possibly pay them back, and these were extremely predatory. So all of this culminated in really millions and millions of American households being very over-indebted, and yet floating by, thinking that they could pay it back. In a sense, covered up growing income inequality and stagnation in real wages and salaries among most of the population, and then after 2005, housing prices began to decline, and then in 2008, everything simply explodes, and you have the crash, housing prices are now about 30% below what they used to be.

So the fact that people didn't save, and the fact that people thought that they could save through increasing housing prices led to this enormous crash, and just a terrible loss of household wealth among a huge portion of the American population.

Romesh: Perhaps we can come back to talking about that post crisis world that the American public faces. The way you describe it, you're a historian, so you come at it from a rather different angle from economists, the whole host of different ideas, institutions, cultural developments coming together to precedence. Then again, you see in the book, a real contrast with many other societies, particularly Japan, other East Asian societies and European societies. What are the broad differences, if you like, between what has happened in America and what has happened in these countries?

Sheldon: You can say two differences, historically. One is, in most of the other advanced economies, there are much longer histories of institutionally promoting small saving. That is, saving among ordinary people, not the big investors, but ordinary households. This goes back to the 19th century and setting up savings banks, and post office savings banks, and then war savings campaigns in the two world wars.

And a host of institutions set up largely by governments, usually central, sometimes local that promoted as a social goal, and as a political goal, that everybody be invested in savings account of various types and that they build up their nest eggs and that they not be a drain on society's resources, and it became a real social good. Now, in America, there certainly were pockets of very good saving, but we have a much weaker historical commitment to promoting small savings, except for the period right around World War II and right after World War II.

In the 19th century, very few savings banks, really, a ridiculously weak postal savings system that nobody can even remember from 1910 to 1966, and in general, that it has not been a major social goal, or political goal to promote small savings. So that's one major difference. That would tie together Japan and South Korea on one side, and European nations on the other, including Britain, again until about the 1980s.

The other difference is the availability of credit. There has been much more, one would say, cultural and political resistance to offering too much credit to people, both in Japan on one side, and most of the continental European countries on the other. To this day, in places like Germany, Italy, Belgium, people don't have what we would call an American-style credit card that is a revolving credit card that you can borrow against. Almost all of their credit cards are offered by the local bank, and they are tied to one's bank account so that you really can't go too far. And they're very strict if you do.

Continental Europeans, particularly central Europeans, have very strict procedures for people who become over indebted. You could call it a tough love approach. Americans have personal bankruptcy laws that are quite liberal, that offer people a fresh start. In places like Germany and Austria, when you get over indebted, first of all, it calls for a legal process, and really a social policy process. Social workers straighten you out, they plan your payments, and you are expected to pay back more or less everything over a long period of time. So this is also a disincentive to take too much credit. Not much credit is offered, and there are severe punishments for those who become over indebted. These are the big differences, I think.

Romesh: So these feel like they're almost sort of deep parts of the foundations of these different nations. The American belief in freedom and not being controlled by anybody, not least by the government whereas perhaps in the European countries and in Europe, there's an openness to being more directed and encouraged to do things, to be nudged to do things perhaps.

Sheldon: It does seem to come out that way, but then we always have to ask how these cultures get formed. One of the things you could say to refute that in the case of the US is that in this period around World War II, early post war period, the US government had no problem promoting small saving among people.

Workers were expected to have regular deductions to buy US savings bonds. School children had US Treasury programs in World War II, in the post war period in the fifties. There were school savings programs in many cities in the 1950s. So it's not that we are totally opposed to government intervention, but that our society, like most societies, has evolved and as it has evolved, cultures have been reshaped.

Certainly the culture we have today in the US has long term formation, early post war period, but it's really the 1980s and 1990s and early 2000s that contribute to the "radical notion," as you say, of freedom and government not really doing anything to protect consumers and savers from this market.

Romesh: Can we talk a little about what the real motivations are for savings? I mean, it's “precautionary savings” economist talk about. Saving for a rainy day, kids are encouraged to save up to buy what they want. People in the workplace are encouraged to save for their retirement. Can you talk a little bit about those kind of motivations and how they fit into these different stories in different countries?

Sheldon: It's a great question because motivations not only vary by individual, but they vary by historical period and they certainly vary by country. The idea of saving for retirement is a relatively new idea because people didn't used to live so long. The saving that most people did in the 19th century would have been for fairly immediate needs. If you were an apprentice, it's to buy tools or to move up to the next step to own your own business. So it’s a lot of saving for immediate investment in self employed small businesses.

Certainly saving for medical emergencies which happened all the time before national health insurance. In America, it still happens because we don't really have a national health insurance system. In America today, the surveys of lower income households show that very few people are motivated to save for retirement because that seems almost impossible. They are trying to save so they can cover car repairs so that they can commute long distances around big cities to get to where they need to go.

Economists in America have often come up with things like the "Life Cycle Thesis," Modigliani and Friedman and others. All that is predicated that they somehow know that people are only saving for retirement. Well, that's not true. That may be one thing people save for, but that's not the only thing. You brought up saving up to buy things. It's a phrase that's actually become quaint in America. Again when you look at Germans and you ask them, "Why do you save?" They say, "I want to save up because I want to buy something."

Americans think that's very strange today. "Why do you need to save up to buy things? You use your credit card or you take a home equity loan." So we do have some rather striking differences in motivations, but one of the puzzles is why Americans don't save more given that life is relatively uncertain and insecure for them compared to European welfare states.

Romesh: Exactly. Think of it perhaps the other way around. If there's a big social safety net, you're less likely to save perhaps.

Sheldon: The American economists have told us for decades that anybody getting a generous national pension or getting social benefits in a welfare state has an absolute disincentive to save, and yet we see it's exactly the opposite. We see Germans, and French, and Belgians and Austrians with elaborate social benefits and they're saving 10%, 11%, 12% and Americans who have very few of these things, other than a national pensions system, are saving very little.

Romesh: Presumably you would want to see more savings of the kind that goes on in Europe and Asia going on in the US. Are there particular savings schemes from history or other countries now that you particularly like or think that would be really worth encouraging the development of in the United States?

Sheldon: I do. One is we clearly need to return to accessible saving institutions for the small savers. We have no problem with the affluent. They are able to save. They don't need encouragement to save. They have access to institutions, so that's not the problem. The problem has been historically in the last 200 years - How do you get lower income and middle income people access to saving institutionss that might take relatively small deposits from you on a regular basis? But small deposits might have relatively high transaction costs. How do you accomplish that social good of getting people into savings accounts in banks? In America, we've done a terrible job in that. We really don't have small saver institutions anymore. It's almost all commercial banks. They have been singularly unfriendly to small accounts. They cite low profits and high transaction costs. They're actually starting to assess fees, major fees, on the poorest of their savers which drives lower income people away from the banks.

We need a government policy that one way or another either mandates, or gives certain tax advantages to banks, or one way or another nudges banks into doing the right thing and accepting small savers accounts, whether it's subsidized by the state or not. We need comprehensive school savings programs, or “financial education” would be a more modern term. This was a big story in the 19th and early 20th century all around the world. Less so in America, but very comprehensive in other places.

Clearly it's not that we have to tell children to "save, save, save," but we have to educate them about the array of financial products out there, from credit to saving to investment. We have to educate Americans at the earliest stage about what risk is. So many Americans went into the stock market and put their retirement savings in without really a very clear sense of what the risks were, the downside. Clearly people have to better educated.

And then the other thing is on the more negative side, we need to regulate the consumer finance industry much better than we have. It's been virtually unregulated until recently. We now have some new legislation. We now have a new agency, called the Consumer Financial Protection Bureau, that came out of a reregulation law over the last couple of years. The problem is the Republican Party is trying to sabotage it at every turn and at this point, a director has not even been appointed of this new bureau because the director has to be confirmed through the US Senate and the Republicans are blocking anything because they and the financial industry are very opposed to any efforts to reregulate consumer finance industry. Then that would be things like credit cards, and home equity loans and things like that where clearly the financial industry needs to provide more information to the consumers. They need to tell them about the risks and they need to stop being quite so predatory.

Romesh: Final question, Sheldon. The crisis, the collapse of sub prime and the suffering that's gone on for so many Americans in the wake of it, it feels like the culmination of your story that started back in the post-war years. What do you see now as the prospects going forward in terms of potential changes in the whole culture, perhaps moving from a society that's just founded on credit and debt back to a society where savings is more important?

Sheldon: That's a difficult question. I don't think that it's happened yet. It's odd that it hasn't happened yet because we're now about three years into the economic crisis. Whether it's technically a recession or not, clearly the stagnation is there and we haven't seen appreciable changes. Now we have seen a rise in the personal savings rate which had been almost zero, then at one point it went almost up to 6% and now is trending down and it's maybe 4.5% or 5%.

It's OK, but the problem is it's an aggregate rate and it's mainly because households at the more affluent level, which have the capacity and margin to save, have been stocking away a lot of money because they're scared because they realize stock market and housing prices aren't going to boost their household wealth anymore, so they've gone back to saving.

The problem is that most people at the lower and middle income levels, the household surveys we have show that there hasn't been an appreciable rise in saving, partly because they are in desperate shape. Unemployment, medical emergencies, a few million home foreclosures since 2008, the sorts of combinations that don't lead people to save more because it's actually taking away their wealth.

So how we're going to get out of it, I'm not sure. There are certainly these policies that I've outlined. They could be extremely helpful, but they all face a great deal of resistance.

Romesh: Sheldon Garon, thank you very much.

from: http://www.voxeu.org/