Thursday, December 25, 2008

Confidence – key to growth

On March 30, 2007 I wrote about how important consumerism was for growth. Before and since then I have always discussed how important consumer confidence is to the development of economies, and capital markets in particular. Over the past few months we have seen where the global markets and economies have been collapsing. This also is as a result of confidence. It was being overly optimistic (confident) in the first place that led capital markets and economies to expand beyond the support of the productive bases, and it was the rapid loss of confidence that caused the faster decline in capital markets and economies globally.

Confidence and GDP
The table shows two confidence measures for the US compared to the quarterly real GDP outturn. It clearly shows that preceding the downturn in US GDP in 2009 there were significant declines occurring in confidence measures. The state street investor confidence index is a measure of confidence by looking at actual levels of risk in portfolios and the University of Michigan index measures the financial conditions and attitudes of households in the US.

This comparison is not surprising as it is confidence levels that drive spending habits and investments. Consequently if spending and investments are subdued because of a lack of confidence then naturally GDP levels will as a result decline. In order for economies to grow therefore confidence levels are important ingredients. No where is this more true than in the US where 70 percent of the economy is made up of consumer spending, and the US economy accounts for 25 percent of world consumption.

Even in an economy like Jamaica, where the state has been guiding resource allocation for many years, confidence is of utmost importance. Even more important than consumer confidence in Jamaica is investor confidence. This is because a significant part of our economy is not driven by the market but rather by paper pushing of financial institutions.

The fact is that Jamaica’s economy has been structured since the 1990s to be one based on trading of paper rather than economic activity. This is why it is so important that the management of the macro economy is far more important than the stimulus to the real economy, because we do not have much of a real economy in Jamaica. This means that even if the consumer were to spend much less this year than last year, the effect on the economy would be small compared to any fall off in trading of paper in the economy.

In any case this reveals that in both the case of the US and Jamaica confidence is key in driving the economy forward. The difference is that in the US the confidence of consumers are most important. In our case, however, the confidence of investors is most important. Understanding these differences will allow us to understand what policies are to be put in place in order to keep our economy afloat.

Regulatory need

It is this understanding of the importance of confidence in the sustainability of markets and economies that lead us to conclude that regulations and policies to drive confidence are utmost to economic development. So when people say to me that the era of the market economy is dead, this type of argument is only a representation of their limited sense of understanding what drives market economies. The need for regulation, especially as it relates to the financial sector, is not to introduce a socialist way of running economies, but to engender the necessary confidence to drive the market economy. The need for a fiscal stimulus package to drive the economy in times of recession is not to move away from the capitalist model (that has served this world so well) but to bring back the necessary confidence in order to allow the market economy to once again start growing.

The problem that we have when we start thinking about the demise of capitalism and the need to go to a more socialist type model is that we tend to over-regulate and over-control, which ultimately leads to a lack of market led growth. It is this very same situation that has led to the lackluster economic development that Jamaica has seen since the 1970s. Some persons have expressed to me recently that my view that agriculture can be the driving force behind Jamaica’s development is unfounded, as it has failed this country over the years and the way to go is high end services.

The reason why agriculture has failed is not because it does not have the potential necessary to drive Jamaica’s development. It has failed because there has been too much state intervention in the allocation of our agricultural resources and too little in terms of dealing with the very serious problem of praedial larceny. Imagine if we had policies that were geared towards (i) ensuring good roads for transporting agricultural produce, (ii) eliminating praedial larceny, and (iii) designating lands for agriculture instead of houses. This would engender the necessary confidence in investors so that they would make a business out of agriculture.

I always tell the true story of a well known Montego Bay businessman that invested 100 acres in mango production for export. As is expected in Jamaica he began having a serious problem with praedial larceny and finally caught the perpetrators on camera. Armed with the visual evidence he carried them to court and after a year the case was thrown out as the tape recording was not allowed as evidence in the courts. As you can well imagine he changed the use of the land from the planting of mangoes for export to building houses for consumption. The fact is that he no longer had the confidence that the system would protect him.

So as we move into 2009 I believe the most important policies are going to be those that are geared towards rebuilding the confidence of investors. This is especially true in a global environment that is going to pose serious economic challenges. The US is yet to face further job losses and only this week the housing numbers show that the recession is deepening in the US and the UK.

Here in Jamaica we have to ensure that our economy is still seen as a viable place to invest and this can only come about by creating an air of confidence. It is going to mean changing the way we do things and we must address as two of the most important impediments to investment, the problems of crime and bureaucracy. Even with the fiscal and economic stimulus package announced by the Prime Minister, if we are unable to deal with the problems of crime and bureaucracy then come this time next year we will be in a worse position talking about the same challenges.

Friday, November 21, 2008

Will the US bailout plan work?

A few weeks ago when the US Congress approved the US$700-billion bailout plan, some people were comparing it to FINSAC, as the plan at the time was to use the funds to purchase bad assets, as well as take some equity stake in some of the failed companies. This comparison was even more highlighted with an equity stake in AIG. This newspaper had asked the question if this action was a vindication of the action taken by the Jamaican government in the 1990s and some professed that it was in fact so, and even suggested that the US consult with some Jamaicans.

I pointed out in an article around that time that I was of the view that the action plan proposed by US Treasury Secretary Paulson at the time was not going to make much difference to the economic downturn and that it was rather premature to be talking about vindication of the Jamaican 1990s actions, as the US plan had not been put in place, much less to see what the results were. My view that the plan would not have worked was that buying bad assets and equity stakes in companies would not have solved the underlying problem of real loss of wealth. Shoring up a company's capital base will not increase economic activity.

In fact, the action by the Europeans, to state publicly that they would guarantee bank deposits, had a much greater effect on stabilising the financial markets than the truckloads of money committed by the US Congress. So maybe there was actually some consulting with the Jamaican players at the time by the US government why their ship still seems to be sinking. I have not heard anyone who came out and professed vindication follow up with a story about how it has worked as yet, and am still awaiting the discussion on it so I might be educated on how to solve a financial crisis.

The fact is that Paulson seems to have learned the art of flip-flopping from not only John Kerry, but some of our local politicians also. He has now come out and said that he will not be using the "bailout" money to buy bad assets anymore, as he first proposed, as market conditions have changed. This is one of the most flawed arguments I have heard and is an indication that Paulson did not have a plan in the first place. The fact is that the fundamental problem with the US economy has not changed, and obviously what he is aiming to address are the symptoms and not the underlying problem.

So here we are again, with Paulson changing his approach to solving the crisis, and the US automakers are the next group standing in line for a bailout, which based on the economic fundamentals, will not be the last group. So the great US is turning into a socialist state, and this is going to lead to a significant slowdown in global growth if they are not careful.

I have no doubt that the US will be the last economy to crawl out of the economic downturn, and this is for the following reasons.

1. The US economy is over 75 per cent services and only 25 per cent in industry and agriculture. Other economies such as China and India are only about 60 per cent services, and the economies that are more geared towards industry and agriculture will be the first sectors to recover;

2. The US authorities dealing with the crisis don't seem to have a proper plan, and the approach to bailout companies in an attempt to stem job losses will not lead to a resolution. It will only slow down the decline, which is going to play out anyway, and cause the pain to be protracted, much like Jamaica's failure to address the fundamental problems in the 1990s caused a long spiralling downward trend for us;

3. The US does not realise that in order to deal with the economic situation they need to change their habits, and are only changing because they are being forced to do so. This will result in another looming crisis, which may be of greater significance, as it affects the real economy directly. That is the credit card bubble. A lot of persons are using their credit cards to maintain a lifestyle that is impossible to maintain because real wealth has been lost; and

4. The full unemployment hikes have not fully hit the US as yet, and is expected to reach between eight to 10 per cent by 2009, up from the current 6.5 per cent.

Would not have worked
So unlike what the proponents of the FINSAC-type solution were saying, the plan that was originally proposed by the US was never going to work effectively. Paulson himself has realised his flawed reasoning and is trying to use changing market conditions to argue away his flawed thinking. In any event, even with its similarities, the US plan did not even go as far as the FINSAC solution, as they were still trying to allow the private sector to run the companies there.
One of the challenges the US faces also is that they are in real danger of losing their position as a reserve currency. I believe that short term, into next year, the US dollar will appreciate some more against the major currencies, such as the Euro and British pound. But as the economic downturn sets in more, and the confused regulators, throw "printed" money at the crisis, it will dilute the value of the US. If they are not careful next year we could see a significant depreciation of the US dollar, as we saw before. The long-term trend is still for the depreciation of the US dollar.

Europe, the UK, China, and India will start to see a recovery before the US and their currencies will appreciate against the US dollar. The US companies will have to look to these other economies for their growth, as US consumers will be hurt badly and there will be no more growing on credit. The "Cash Plus"-type US economy cannot continue anymore.

The US is now at risk of seeing deflation, as consumer prices have dropped the most since the data was being recorded in 1947. This as a result of reduced consumer spending, not because costs are going down and competition is increasing. In addition mortgage applications have fallen off again. The writing is on the wall that the real economic slowdown in the US is just beginning, and should go well into 2009.

As demand in other economies start to turn around, especially in China and India, we should start to see a recovery in commodity prices. So as the US economy continues its slump, and other economies start to recover, we could see commodity prices starting to increase again. As I indicated last year on the radio, what we are witnessing today is the beginning of the changing of the guard to a new world economic order. The US will still continue to be the main economic force for a while but this is the start of a changing of world economics. A lot is riding on Barack Obama.

So in my view the US bailout plan has failed to do anything positive for the economy. The way it was handled has clearly shown that the US authorities have not really come to grips with what the fundamental problem is and the Treasury secretary has shown that he does not have a well-thought-out plan. I really wonder if they had sought advice from Jamaica on how to address the crisis?

Friday, November 07, 2008

Yes we can Jamaica

The historic victory of Barack Obama for the presidency of the United States of America (US), demonstrates to the world not only that anything is possible but is an indication of the greatness of the US. This is a country that only a few weeks ago was written off by the whole world as a dying superpower and an economic failure. I still believe that the worst of the economic downturn is yet to be seen in the US, as the crisis continues to hit the earnings of Main Street and more jobs are lost. But the wave of hope that has hit the US and the world demonstrates how important confidence is, as there is now a feeling that the US will rise like the Phoenix from the ashes and retake its rightful place as the leader of the world, not only economically but also morally.

There is no doubt that the Bush presidency has seen the US go through the worst time in its history as a superpower. The economy is in shambles; the spread between the rich and the poor is greater (the middle class is disappearing); international relations are at their lowest point and the US is engaged in armed conflict all over the world and is in a war it cannot win. During the Bush presidency the US lost its moral authority to be called the leader of the world.

The rise of Obama
The rise of Barack Obama is not only a positive for the US but also confirms the idea that capitalism and democracy are the best economic and political systems to date. It is these two systems that have made the US great, as it always gives the power to the people to do what the US seems to do time and time again: renew itself. Only with democracy and capitalism can this renewal happen. The US has gone through many economic recessions and some presidents who have not been seen favourably, even though the time under Bush seemed like the worst.

The real power of the US, however, is the will of the people that is facilitated by the political and economic systems they have. These systems give the people of the US the opportunity to make changes to what is not going right, and this is what makes them such a great nation. Government for the people and by the people in its truest sense. This historic victory shows us that in the US the urge to better itself is even more important than the remnants of racial or party divide, as the people will always put the US first.

I never thought that in my lifetime I would see a Black president of the US. I thought before that experience I would have seen Jamaica stop on the destructive path we are on and start a real process of economic and social development of the people. This has been my real passion and I am yet to see that happen. Instead I continue to see worsening economics, crime, police brutality and social deprivation in the country that I am a citizen of. So while the US has again made history, and we praise what has happened there, we also need to realise that of the 6 billion people in the world, only 280 million (or less than 5 per cent) live in the US. There is also a little country named Jamaica with 2.7 million people who have been crying out for a miracle.

And even with our reputation as having the most churches per square mile, it seems as if the church has failed to bring any morality to Jamaica. I could not believe my ears that a clergyman, and pastor of a church, could call for the resumption of hanging. This gives the impression that the church is not in the business of saving souls, but has joined the ranks of the gunmen who condemn souls. Or is it really the souls that they are trying to get at and not the flesh? What is even more disheartening is that the media, which has disappointed Jamaica with their own corruption and inadequate leadership on opinions, could continue to give credence to this ridiculous statement by covering it. How can we promote capital punishment in a country where the organs of the state, which should be controlling crime and maintaining discipline, are corrupt and inefficient? This would only provide the corrupt and inefficient system, which we have created, with the opportunity to hang innocent people who do not agree with their views.

Dishonourable leadership
And while over the years Jamaica, and in particular the common Jamaican, has sunk deeper and deeper into poverty (I disagree with my friends who claim that , more cell phones and used cars indicate progress of a country), the politicians who have been responsible for the last thirty-six years of decline do nothing more than shower themselves with honours, which have now become meaningless as there is nothing honourable about the actions of our leaders.

I was at a lunch meeting recently with some Jamaicans who have sought to improve this country, and they also still hold out hope for Jamaica but all agree that only a change, as proposed by Obama, can do any good, that is, a fundamental shift in the way we do things. If the house is structurally unsound then a new coat of paint will not fix the structural problem. It will only cover up the obvious cracks in the wall. Most Jamaicans cannot build a new house, as some Jamaicans can do through migration, they have to continue to live in the structurally unsound and rat - infested house. It is up to the leaders of this country, in the private and public sector, media, and academia, to rebuild the house on the foundation we call Jamaica for the good of the Jamaicans who cannot afford to do so.

For those who have said to me that Jamaica has proved in the 1960s that it can develop, I just have one thing to say. Like maybe about three or four generations of Jamaicans, I was born after independence and grew up in Jamaica during the 1970s to 1990s. So excuse my cynicism and urgency for a better Jamaica. I have never known what it is like to be in a Jamaica that is prosperous and is looking towards a brighter future. So while you all reminisce about the hope in 1962 and the good times of the 1960s, remember that all I know about Jamaica is the state of emergency in the 1970s, the 1980 election, the black market and foreign exchange restrictions in the 1980s, the financial crisis and high crime rate of the 1990s, and the anaemic growth and fiscal deficits continuing into the new century of the 2000s. This is the reality of most Jamaicans today, which you are responsible for developing into an aggressive set of people by the experiences you have left us with.

Jamaica, yes, we can make a change too. But it will not come by doing the same things we have been doing over the years and expect different results. It can only come though a revolutionary change. A different way of treating our people with the respect they deserve. A fundamental shift in how we approach our economic, political and social relationships. It won't come from constantly trying to destabilise the government in power, which seems to have been the purpose of much opposition over the years. It only comes from accepting that we are all Jamaicans and have a responsibility not only to each other but to working with the government of the day to achieve a better Jamaica. One thing about the US is that no matter how bitter the political contests have been, they always unite in the end for the good of the party and country. This is because they realise that the purpose of political power is to build the US and not line their pockets with the proceeds of debt.

So while we celebrate this historic victory for the world, in the election of Barack Obama, Jamaica should also believe that yes we can change, but this takes deliberate actions by Jamaicans and our leaders to transition from "yes we can" to "yes we will".

Friday, October 24, 2008

To owe or not to owe

There is no doubt that the economic crisis in the US will get worse and thousands more will lose their jobs. As I indicated in an article a few weeks ago, the original bailout plan fashioned by Congress would not have had any effect on the credit or equity market because it did not address the underlying problem, but rather sought to deal with wiping the blood from the wound rather than putting a stop to the bleeding. It wasn't until after the statement that interbank loans would be guaranteed that some hope of credit came back to the market, thanks to the solution proffered by the Europeans.

In my own view it was not even necessary to commit any funds to the crisis, as all that was needed was to bring back confidence to the system. The amount of funds offered in any bailout plan will have no effect if a market loses confidence, because markets survive by the will of behaviour rather than any amount of funds or government intervention. The best role for a government is to support the natural laws of the market rather than intervene too much, as we have come to realise from our own experiences.

The effect of debt
The other consideration coming out of the current US crisis is the matter of debt. This is an effect we know only too well in Jamaica, as during the second half of the 1990s we began a path to racking up a level of debt that would eventually condemn us to the serious economic challenges we face today. I guess we can always boast that the great US followed our own strategy of living beyond our means and take some pride in the fact that we are in the company of the US.

As I have always said, the absolute level of debt is not an issue. So whether we owe $100 million or $1 trillion is irrelevant. What matters is the marginal return on each dollar of debt compared to the marginal cost. As long as the marginal earnings from each additional dollar we borrow is greater than the marginal cost, then it is okay. As soon as the cost of the debt becomes greater than the return from each dollar of debt, then it becomes an issue. So when debt is used for consumption rather than production it is always going to have a higher cost than the return, as maybe the only return one gets from consuming borrowed money is an increase in the numbers of "hangers on".

So what happened to Jamaica was that we borrowed money to support a lifestyle that we did not earn. In other words, even though we owe a lot of money which our grandchildren will continue to pay, we look good owing the money. Some of my friends argue with me that Jamaica is more developed than other countries in the region as we have better-looking cars, more cellphones and technology penetration, better-looking roads, and better houses. While this may be true, I don't think this alone is a measure of development.

This has been illustrated by what happened in the US also. And I have no sympathy really for anyone who by reason of their excesses find themselves in serious financial difficulties. Jamaica itself has earned the right to the economic difficulties we find ourselves in. No one put a gun to our heads and forced us to borrow the money and waste it on consumption and activities that cost us rather than provide us with a return greater than the cost of the funds borrowed. We made that decision on our own. The problem is that even those who had no part in the decision are suffering. Similarly no one forced the US consumers to find themselves in a position where the savings rate was negative. And while they were enjoying the fruits of poorly managed debt (the latest car, big house, etc) they never sought to share it with those who were being prudent. So why then when the chickens come home to roost do we hear of the difficulties being faced? Just as they were enjoying the previous excesses, then they should similarly enjoy the results of the excesses.

World crisis
Because of the excesses of the US economy over the years, the world is now faced with an economic crisis that will get much worse and which we will not be able to recover from for years to come. The basic principle of what happened is that the US consumer was living on debt with no real income to support the debt. So they would borrow money to buy a house and even while owing on the house then they would borrow money on the equity in the house for personal spending. Because everyone was doing it the market price of houses escalated beyond the real value, based on expectation, and seeing more equity in the house the consumer borrowed even more for consumption. The money that was borrowed on the basis of the artificially growing equity was not used for investment but rather consumption, which had no returns attached to it.

So when the prices of houses started to fall because of a fall-off in demand, the money borrowed based on the equity became a problem because the equity in the house had fallen off significantly. So the "poor" consumer ended up with a debt far exceeding the value of the asset, and what is more, because the market value of the asset was being driven by unreal expectations, then it will not for the foreseeable future come back to the peak value on which debt was borrowed.

This created not only an issue for the consumer but also the bank that lent them the money as the asset values on the balance sheet now started to decline, and the liabilities were increasing as loans grow based on the rate of interest. Now multiply this effect by millions of people and we have the current global financial crisis. The problem now is that we will not in a very long time recover the wealth lost, which will continue to lead to cutbacks in companies and personal consumption. The result is similar to a balloon that is quickly losing air and so gets out of control.

In Jamaica we did the same thing by borrowing money to postpone the medicine of market adjustments. We borrowed to control inflation, the exchange rate, and buy more cellphones and cars, building a few stadiums along the way. In other words we took part in the same excesses as the US consumer. But it was okay to do so as long as the world economy was growing as it meant that more wealth was being created and we could always get more money to borrow to support our "champagne" lifestyle even with our "soft drink" income. Our desire for the farcical development meant that we were always willing to borrow money to spend on consumption, as even though we owed a lot of money we looked good while doing so.

What has happened to Jamaica now is that the curtain has been closed on the grand global partying. The final act has been played and we find ourselves as actors out of work. We can no longer get money from foreign investments and debt as easily as we used to and even if we do it will cost us more. This will no doubt lead to us having to cut back on our national standard of living as the US consumer has to do. The difference between Jamaica and the US is that unlike them we have no reserves to help to cushion the effect of the crisis. So when one calls on government to intervene financially it seems as if there is a failure to understand that even in the good times the money that we were spending was never ours, and as a country we had no savings.

The only thing we can do as a country is cut back on our lifestyles and change fundamentally our production relationships. Of course another problem is that the economy is 70 per cent services, and without real production there will be little money to buy any services. Even as we move forward with this dilemma we will be tempted to borrow even more to ease the pain. The question will surface again, "To owe or not to owe". The answer has always been, and continues to be, only as long as the marginal revenue is greater than the marginal cost, and we ignore this at our own peril.

Friday, October 17, 2008

Is capitalism dead?

Recently the world has witnessed the biggest financial meltdown in almost a century in the great superpower, the United States of America (USA). Because of the financial crisis in that country the world is facing a global economic recession and is also on the verge of financial and economic reorganisation. The result for many is that there has been a significant loss of wealth, which in my opinion will never be fully retrieved in the short to medium term.

The global meltdown has raised the question of whether or not capitalism is a sustainable economic system. Even my friend Betty Ann Blaine has written about "The free market farce" in last Tuesday's Observer. The global events that have overrun us will no doubt lead to a vibrant debate on which economic system is best for development. Even in the US presidential debate the question of how much government intervention is appropriate in the markets is a point of discussion. I have heard many people use the recent financial events to even go as far as to suggest that capitalism is dead.

Best economic system
I myself am someone who believes in the power of the market and I still believe that capitalism, as an economic system, is the best ever developed. Despite the 1929 Great Depression, and today the 2009 Great Financial Crisis, capitalism as an economic system has delivered the best results to global economic progress.

Anyone who did economic history will understand how much capitalism has contributed to the development of global economies. Economic systems have included slavery, feudalism, socialism, and communism. In both the cases of slavery and feudalism, it has included a clear ruling class that by virtue of their colour, or class, has controlled the capital of the country. So, in both these cases, capital was not allocated to the person/activity that had the best idea, but rather was distributed according to birthrights. Under socialism and communism, the distribution of wealth and capital undertaken primarily by the state, and disrupts the efficient workings of the market.

We have seen in recent years the fall of communist economic systems such as in Eastern Germany, Russia, China, and closer to Jamaica, Cuba. In fact, China's economy has developed more since it adopted a market economy than any other time in its communist history. This is because the strict allocation of capital by the state will eventually lead to corruption and inefficiency, which will mean that the efficient adjustments in markets will be disrupted, eventually leading to very low productivity levels, uncompetitiveness, and lack of opportunities. This is not dissimilar to the way Jamaica implemented the MOU, which resulted in no incentive for productivity. So instead of helping our productivity, in the long run it has caused further strains on the public purse and kept the government bureaucracy inefficient, resulting in a loss of productivity in general, as I stated would happen when it was first introduced a few years ago.

So even though Jamaica has purported to promote a market economy, the fact is that we have only had an attempt at a market economy, and this is a primary reason why we have failed to grow at internationally comparable levels over the years. In fact Jamaica has never really benefited from globalisation because we have never really opened up the market to competition, as the state has always sought to control most of the resources in the country. This was formalised during the 1990s when the creation of FINSAC formally gave the government control over the private sector.

The challenges in the financial system, first in the US and then globally, are in my view not a good reason to call for the end of the market economy, which is undoubtedly the best economic system available. The market economy works according to the natural laws of nature, in that it will always adjust to equilibrium in the long run. Economists have long accepted, however, that laissez-faire (totally free market workings on which principle capitalism is based) is not a desirable economic system. The reason why laissez-faire would not work is that man rightly understands that he has a responsibility to protect the weak in the society, and if there was no government, then the weak would die as the laws of nature dictate. Even in the animal kingdom the weakest animals, even within the same species, will die. So economists have long recognised that government is necessary to protect the rights of the weak and also to ensure a country's development, because if there was no government we would not necessarily have roads or a security system for all (which we don't have even with government).

So we can all accept that government is necessary if we are to protect the rights of all people. Whether the rights of people are protected or not depends on what political system is in place, of which the most successful has been democracy with a republican-style constitutional arrangement. When government gets too involved in the efficient running of the market, then markets will fail over the long term and long-term growth will be sacrificed. Because a market economy has failures every 100 years or so does not mean that capitalism has failed. Such an emotional reaction is, as we would say, throwing the baby out with the bath water. For if we look at capitalism's long-term contribution, the benefits far outweigh the disadvantages. A true market economy, with government in a support role, is the only way to develop in the long term.

The current global crisis, and even our own 1990s crisis, was not caused because the market failed but because there was too much government intervention. It was because both the US and Jamaican governments intervened too much in the efficient running of the economy that both crises happened. In the case of Jamaica, instead of allowing the markets to adjust by forcing us to be productive, we sought to control inflation and the exchange rate, which is what forces us to adjust our production arrangements, by keeping interest rates too high for too long. This, in effect, killed businesses in Jamaica.

In the case of the US, because the politicians wanted to give people the opportunity to own homes they kept interest rates too low for too long. This resulted in the natural laws of the market going to work and people borrowing at the low rates to make money, eventually leading to a credit bubble that had to burst. A market economy does provide controls on excesses, such as an animal has a limit to its stomach's capacity to prevent it from overeating. But if an intervention is made to surgically extend the size of the stomach, then overeating could cause death.

So in both cases, it was not the excesses of the market that caused the challenges in the market but rather the excesses of politics. It was government intervention that put the spoke in the wheel of capitalism, eventually leading to the collapse of the markets. This is why it is essential that the proper political system accompanies the efficient market economy system, which is the problem our own country has faced over the years. And this is why I have always said that Jamaica does not have an economic problem, what we have is a political problem, as our constitutional arrangement is at the heart of our problems.

So to everyone who wants to question capitalism as an economic system, I say capitalism forever. It is the only system that has delivered the global progress we have seen since the 1980s, and has delivered to us a better standard of living. The problem with capitalism is that it has always had to contend with the excesses of politicians and inefficient political arrangements.

Friday, October 03, 2008

Understanding the US bailout plan

The last two weeks have been tsunami like for financial markets across the globe. The failure of the US bail out plan to pass Congress on Monday made things seem worse, as markets reacted to the decision of the Congress . And unlike what we have become accustomed to in Jamaica, the members of the lower house listened to the people who put them there, for better or worse.

I am one who believes that the bailout plan, as was being proposed on Monday, would not have made any fundamental difference to the crisis being faced. What happened in equities on Monday was more a reaction to disappointed expectations more than any fundamental changes in market conditions. If you look at it what significant changes happened to markets between Friday and Monday last. The only difference was that there was an expectation that the bail out plan would pass and it didn't.

Disappointed expectations
As I have always said, we must remember that economics is a social science and so it is about market behaviour. The reason why it became necessary to pass the bill on Monday was that it was clear that expectations were that if it didn't pass there would be a significant fall out of equity markets. Consequently the market priced in the expectation that the Congress would pass the bill, and when it didn't the market became jittery amongst the gloom and doom predicted and sold off the purchases they had made, as they expected that markets would plummet. So said so done, as the DJIA had its largest point drop ever and the highest percentage drop since 9/11.

My view is that because of market expectation and reaction the bill will pass today, as fear sets in based on what happened on Monday. And although I agree it is important to be passed it is even more critical that careful thought is given to the details of its implementation, as just merely pumping in US$700 billion in the market will not make any long term difference if it does not address the underlying problem, as we found out with our own bailout plan. Even though we cauterized the fallout of the financial system, in the 1990s, we did it at the expense of negatively affecting long term economic prospects, thus resulting in an economy based on credit just as the US is today.

In order to understand whether or not the bailout plan will work it is not enough to look at the size of money involved or whether it will stop the slide of the stock market but rather will it address the underlying problem. What the initial plan failed to do was to address the underlying problem, and the fact that it was designed by Paulson and Bernanke, and supported by Bush, makes no difference to its credibility. Paulson and Bernanke have been incorrect about the economy for the past two years, and if they were more aware could have prevented the extent of global turmoil we see today. Bush we all know has been totally off base on the Iraq war, which is one of the reasons for the decline in the US economy today, as it is costing the US billions. So anything they support should be closely scrutinized as a prolonged financial crisis would be just as devastating as any world war.

The fact is that any reaction on the equity markets is just a symptom of what the underlying problem is, and any bailout plan should be addressed at dealing with the underlying issues rather than catering to the cry of a few overpaid persons, who were the ones that created the financial crisis in the first place by their irresponsible risk management practices. Just a note, these are the same people that we revered as financial geniuses, even while the soundness of our financial system was secured by locally designed legislation. Big up our own Jamaicans, who have always been underestimated, unless of course accepted internationally first, while we continue the export of capital and expertise by preferring the foreigners over our own.

Address the underlying cause
The underlying issue to be addressed in the US, is not to be found on the asset side of the balance sheet, but rather on the liability side. The problem is not that assets are losing value, and are making balance sheets look bad. The problem is that there is a very high degree of uncertainty in asset values and this has resulted in no one wanting to lend to anyone else as they are not certain about balance sheet exposures for fear of the companies they lend to having to liquidate as Lehman did. Note that when the Fed showed its willingness to save bear Stearns markets responded positively. The uncertainty got heightened only after the Fed allowed Lehman to fail, and at that point the risk of lending in such an uncertain environment increased significantly.
This means that any bailout package needs to address the uncertainty surrounding the lending of money. Everyone who has money to lend would want to protect their own balance sheets from any unknown risk, hence the moves to Treasury Bills and Gold. The revised plan passed by the senate seeks to do that by increasing the insurance limit at the FDIC. What this does is guarantee to those who lend money, through deposits or other facilities, that the US government is backing those funds and so they can sleep at nights. This way people will feel confident about lending monies to the system again.

If on the other hand the government pumps US$700 billion into these companies, by buying bad assets, and the uncertainty about balance sheet values and exposure still exists then this will not free up credit markets. After all before we knew the real effect of the mortgage backed securities we did believe that the balance sheets were sound, so the details surrounding how the government identifies and values bad assets is going to be important, and even itself is uncertain. And this is why the liability side of the balance sheet ( liabilities to customers and counter parties) is more important than the asset side, which is the original bill's focus. I think it may have been a blessing in disguise that the bill didn't pass on Monday, as a false impression may have been created, from the equity market response, that the problem was fixed when uncertainty remained.

The revised bail out plan includes (I) tax breaks for some home owners; (II) restrictions on compensation to executives; and (III) an increase in insurance on liabilities, and makes a lot more sense but will not be enough to prevent the slowing down of the economy. It will only prevent a ceasing up of credit in the markets. There have been calls also for the suspension of the mark to market accounting rules, and as many of the analysts have said, this is really ignoring the problem. The fact is that people already know there is uncertainty around values and any removal of transparency will heighten uncertainty.

The details of the bailout plan will be important for the world in, as any further tightening of credit in the world's largest economy could have devastating consequences. Even with a proper plan in place the global economy will still slow, and we have not seen the full effect on other developed economies such as Europe and the UK and the emerging economies of China, India, Asia and Russia. It is going to be a wild ride but the powers that be need to be careful not to make the mistake we did in the 1990s of so much intervention that it prevented markets from working efficiently thus causing long term economic stagnation, as where in our case it affects Jamaica only, in the US it will have a global impact.

Sunday, September 28, 2008

Comparing Jamaica's 1990 crisis to the US

Recently I have been asked questions, from various persons, about what comparisons are there

between Jamaica's 1990 financial crisis and the current US financial crisis. And this is understandable, because for us in Jamaica it seems like déjà vu.

There is no doubt that the current crisis in the US is of grave concern for the world, as any mishandling of the situation could lead to devastating consequences for the global economy. It is therefore very important for this proposed bail out plan to be handled properly, as the US unlike Jamaica, cannot afford room for any mistakes, as the global consequences are too significant.

On the one hand, while the Fed and Treasury is proposing this US$700 billion “bail out”, the Congress is very carefully considering the details of the plan, as they are all about protecting the taxpayers' interest and ensuring that in the long run cost to the taxpayer is not significant, if there is any cost at all.

There is no argument that some intervention is necessary by the US government, just as intervention was necessary in the 1990s in Jamaica, but the manner in which it is executed is very important, as it could affect the long term viability of the economy and the ultimate cost to the taxpayer.

The following table provides a brief comparison of Jamaica's 1990s crisis versus the current US crisis.

These are some of the main differences between Jamaica's financial crisis and the one in the US. In both cases they are the worst economic shock as far as I can remember that has happened to both economies.

While in both cases the bail out was necessary, there is a fundamental difference in approach. It is clear that behind the philosophy in the US is the need to stabilize the markets but not to interfere by government acquisitions. In our case our philosophy was to stop the crisis by talking over the entities, but what we ended up doing is creating a greater burden on the economy, as the bail out package as a percentage of GDP was too great, and created a significant fiscal challenge. In addition the fact that government took over the productive sector and left interest rates high meant that the productive sector was effectively killed, and it was more attractive to invest in high yielding government paper.

It has been more than 10 years now that our crisis has occurred, and hindsight will show us that we could have approached some things differently. It is very important for us though to properly study the situation and provide some answers to the taxpayers who have paid dearly for the crisis, and for us to understand if the process was handled in the best interest of the taxpayers. The borrowers of course cannot wash their hands clean though as the business practices in some instances were wanting, and would have had an effect on the results.

There is no doubt that some bail out was necessary but we must try to understand what happened if we are to learn from it and silence the critics on either side. This is why a comprehensive study is necessary if we are to learn, even if more than a decade later.

Friday, September 19, 2008

Facing reality

A very appropriate introduction is the recent action by Captain Burrell to dismiss the once football saviour, Simoes, stating quite correctly that even though Simoes was a good person and a personal friend, he had a job to do and the fact is that he was not getting the expected performance.

When I heard this statement from the Captain, not really having any strong opinion on him before, my respect grew in leaps and bounds. I thought to myself this is a man who is a leader, who recognises what his responsibilities are and acts in an emotionless manner to achieve that purpose.

This is one of the central issues at the heart of Jamaica's failures, because instead of confronting issues head on, and making decisions based on objectives, we are more apt to make political or emotional decisions, and instead of holding people accountable we would rather cover up their inefficiency by creating a new position or additional structure. And this is not only in the public sector. The result is a structure of inefficiency and unproductivity, while we wonder why we are uncompetitive.

Courage to lead
Hats off to the Captain who has shown that he has the courage to lead. If that attitude continues in the JFF then I have no doubt we will return to the glory days of football, when he was also at the helm in 1998.

This courage to lead is also going to be critical in the next 6 to 9 months, as the global financial crisis seems worse than I, and many, had anticipated. On July 18th 2008 I wrote about the makings of a perfect economic storm unfolding over the next 6 to 9 months because of our fractured economic structure, built over the years, combining with the global crisis. At that time I didn't realise how difficult the global crisis would get. Our broken economy has resulted, to a large extent, because our leaders have not had the courage to lead, and instead of putting performers in place have supported friends and political appointees, even in the face of their non-performance. Another reason is that over the years we have always sought to solve a problem by bringing in a foreigner, ignoring the development and expertise of our own Jamaicans, thus exporting capital, and ensuring that the "slaves" never get to a position higher than foreman, satisfying their need for crumbs with "memorandums of understanding". But when the foreigners leave, the expertise leaves with them, and they have little obligation to Jamaica's development.

Recently again (happened in the past) people have sent me emails, and some have said that instead of talking about economic gloom I should think positively. As far as I am concerned, the only place that type of argument belongs is in the warehouse of the NSWMA. How does positive thinking replace reality? Maybe what Captain Burrell should have done was think positively in the hope that Jesus would save us from elimination in the qualifiers. Maybe what the directors of Lehman Brothers should have done was think positively that investors would stop dumping their shares, and on Monday everything would have been alright.

I think some of us have taken the power of positive thinking theory too far. Maybe because I am an accountant I was taught to be cautious and conservative, but the only way to truly deal with a problem is not to think it away but to first and foremost face the reality. If we fail to face the reality, then we will think that the light at the end of the tunnel is daylight and before we realise it we'll be run over by a freight train, instead of understanding that it was a train coming and step off the tracks.

But I have no confidence that those with this philosophy will change any time soon, while I and other pessimistic thinkers will continue to be seen as the prophets of doom. But as long as I am proved to be right, then I have no problem with that label.

Global turmoil
I don't think I have to mention the implications of the global financial crisis. It is very bad in my view, certainly the worst financial crisis since 1929 and has the potential to be geometrically worse than the Great Depression, simply because financial and economic systems are so intertwined in today's global environment that a failure in one market will inevitably cause significant harm in others.

We have seen where the US market has seen the fallout of giants such as Bear Stearns, Merrill Lynch, Lehman Brothers, AIG, and Washington Mutual. In addition the UK has seen its share in Northern Rock and now the acquisition of HBOS by Lloyds TSB. I have no doubt that other financial institutions on other continents will be affected. As a matter of fact, there is a fear now that Asian banks may soon be affected. These situations no doubt will lead to a global recession. Already Europe, UK, and the US are in a recession, and we are seeing a slowing down in other markets such as Canada, Australia, Japan etc. Jobless claims and unemployment are rising worldwide, with the US recording multi year high unemployment of over 6% and the UK recording unemployment of 5.5%. In the meantime, housing starts and mortgage applications are down worldwide (US, Canada, UK, and Australia).

As if that pressure is not enough we also see where inflation was still a global concern. When oil was going down recently I wrote that it was not time to celebrate as oil is still in a long-term up trend, and only yesterday oil bounced back from the strong technical support level of $90 to over $99 at the time of writing. Two days ago gold also had its biggest one-day increase. These moves are just a symptom of the credit crisis, as investors, fearing that money and companies will lose their value, flee to commodities that can retain the value of their investment. This will of course play out more in gold as it is a better way to retain value than other commodities such as oil. For an oil price downturn to be maintained then it will have to close below $90 per barrel, and even then it may not be sustained.

What is clear is that this "accounting" crisis will more than likely continue for a while. This problem started because of weak accounting rules, and has turned into a true global problem. The accounting issue still remains, as companies are still not able to say what the true value of the compromised assets are. In fact Fannie Mae and Freddie Mac admitted that the accounting for their assets was overstated, and even AIG's fall was caused because when Lehman wrote down similar assets significantly AIG's balance sheet became a problem. The only company in March 2008 which said it always marks its securities to market, Goldman Sachs, is the most resilient. Even so Goldman is seeking fresh capital from the Chinese in order to avoid any pounding from short sellers.

It is clear that the global crisis will negatively affect Jamaica's economy, as it will at best slow down the growth in tourism and remittances. There will also be a slowdown in construction, with the only possible saviour being agriculture, as we grow foods for export and more importantly to feed our people, as food security is going to be very important. In any event growth this and next year is going to be restricted, and economic defensive strategies must be adopted.

Technically also a recession is defined as two consecutive quarters of negative growth, and already we have had one. If there is another, then we would technically be in a recession. And there is nothing wrong with saying that, as it is the reality, and we must face if we are to deal with the challenge, as Captain Burrell did.

Friday, September 12, 2008

Impoverishment of a nation

Last week I received emails asking that I write on the issue of the American Airlines (AA) deal. Although there is something to be said, I believe it has been debated enough and there are so many more important issues to discuss. What I have heard being discussed, however, seems very limited, and the only person I have heard who has got the arguments right, in my view, is Wilmot Perkins who said that if we neglect our infrastructure, then both AA and Air Jamaica will be flying empty as no one will want to come to Jamaica. Anyway, enough said on that.

I believe that there is a more important issue that will really affect Jamaica's long-term future. While over the years we have been arguing about Air Jamaica and other issues, what we have been doing slowly is ensuring the impoverishment of the country. For while we are distracted by these arguments, we have been pursuing policies that have created illusions of prosperity while the fabric of the country has been rotting away.

Devastated infrastructure
Nowhere is this more apparent than the devastation caused to our infrastructure by Tropical Storm Gustav. Mayor McKenzie has been addressing this as he spoke of the fragile state of our country's infrastructure, which has been caused by decades of neglect. The pictures of devastation seen on the news indicate that over the years we have failed to properly maintain our capital infrastructure, while giving the impression that we are meeting targets and performing reasonably well.

Over the years, while debating the fiscal budget, I have been constantly making the points that (1) there is nothing wrong with debt as long as the marginal revenue is greater than the marginal cost, and (2) I was always very concerned that we have been trying to meet the fiscal targets by cutting back on capital expenditure. This myopic approach to managing the budget is one reason why we are in the situation today with a very vulnerable capital infrastructure. One example of the long- term cost caused by the lack of maintenance of our capital stock is the cost to productivity of the bridge at Hope River being washed away.

So what we have been witnessing over the years is the impoverishment of the country without understanding it. Instead we have tried to give the impression that all is well and prosperity abounds, by spending money on things such as Cricket World Cup and loss-making entities such as sugar and soaring to new heights as we do so. The management of our public funds was not based on any cost-benefit analysis and what would give us the greatest return on investments. But rather what would give us the greatest "votes on investments". One blatant example of this is the continuing MOU, which instead of helping our productivity and budget, is becoming a greater burden each year.

And so our leaders have presided over the process of impoverishing Jamaica. Let us understand that countries like Haiti did not reach their pitiful state overnight. Haiti got there by a continuous process of irresponsible and corrupt spending practices that eventually gave way to an underdeveloped infrastructure, where today they face disaster each time rain falls, and with each raindrop they plunge deeper and deeper into poverty.

But it is not only our leaders who have contributed to our demise; the population must take some of the blame. The fact is that politicians play to the tune of public opinion and votes, and will do anything that pleases the people to stay in power. So even though we say that we are concerned about the future of the country, make no bones about it, we will trade our votes for J$500 and a plate of curry goat, or a tax break, even if in the long run it means the policies pursued will destroy the country.

Wasted human capital
There is no doubt in my mind that the main impediment to Jamaica's development is the high illiteracy rate of our people. The fact is that over the decades we have neglected our most valuable resource, our human capital. The recent performance by our athletes at the Beijing Olympics and past contributions of others show how much value our people can add to this country. Nothing else has added as much value to Jamaica as our people, yet over the years we have abused their rights and kept them oppressed. And then we talk about development as if it can happen without the people being at the centre.When I look, for example, at the way in which the JPS has placed the burden of an inefficient billing system on Jamaicans, and there is no swift action from the OUR, then I have to ask if as a country we are serious about development. People should not have to be wasting productive time to demonstrate, when we have a regulatory agency in place. But then again, JPS seems to have joined ranks with some of the police who drive into communities and cause pain on the people. Only they have a more efficient way of doing it, as they don't even leave their offices.

But in all seriousness, what we have been witnessing in Jamaica over the last two decades or so is nothing more than the process of impoverishment of the country. The failure to maintain our national capital stock is similar to living in a community where the houses are not maintained. What happens eventually is that the houses are run down and eventually the community becomes a slum. Similarly, because of years of neglect, our capital infrastructure is in such a state that if not addressed all Jamaica will look like a slum. No doubt the government will have to find a lot of unbudgeted funds to address this, as the long-term cost of not doing so will be greater to the country.

There are some immediate actions that can be taken to ease the pain of the journey forward. At the heart of it, however, is the need to ensure that any money spent has a higher marginal return than cost. It is obvious that the planning at the parish level has also been lacking and the question must be asked, was there any planning being done, or any action being taken, at the level of the parish council before Mayor McKenzie? It seems as if everything was just left to be run down.

So as we move forward, while we discuss issues such as the AA deal, let us understand that there are bigger issues such as the fragile state of our capital infrastructure. In the long run if we neglect our infrastructure, then both AA and Air Jamaica will be flying empty as no one will want to come here, and merely having available seats or hotel rooms is not enough to entice people to visit Jamaica.

The government is faced with the unenviable task of maintaining the fiscal target, which is critical, and also assessing our capital infrastructure and other issues. It is going to be important, therefore, now more than ever, that the return on each dollar spent, and how best it is spent, ,is examined carefully. We cannot make the mistake, like we did in the past, of consistently sinking money into unprofitable entities, hosting two-week cricket festivals (where we don't perform well anyway), or wasting money in scandals or for political reasons.

It is going to seem like a long journey to place the country back on the path of development, and will require not only correct policies but restructuring of the whole public sector. It is something we must do if we are to save this country from the path of impoverishment we have been placed on.

Friday, August 29, 2008

Levelling the playing field

Our Olympians have gone to Beijing and have done us extremely proud, and I would certainly like to add my own congratulations. These athletes both displayed an individual and team effort that proves to the world that Jamaica has the potential to be a world force. It also shows us the huge potential that all Jamaicans have and what we can all become.

Probably the proudest moment for me though, was not when Bolt crossed the finish line, or when the women came in 1, 2, and 2. It was every time these athletes stood on the podium and the Jamaican flag was raised to the strains of the national anthem. And even in that proud moment there were mixed emotions as I wondered if a small country of 2.7 million people can dominate the world in track and field, why can't we cope successfully with our economic and social situation at home? After all over the years it has been the individual, and team efforts of our athletes and musicians mainly, that have brought Jamaica its proudest moments. And it is these proud moments that have always allowed us temporary reprieve from the "sufferation" that politicians have created since independence.

Wagonist express
It is McKenley, Cameron, Quarrie, Ottey, Marley, Cliff, Shabba Ranks, Beenie Man, and more recently Veronica Campbell, Bolt, and other Olympians, who have made us feel good internationally. If we were to rely on our leaders, then we would feel like the pariah of the world. It is these people who have come from very humble backgrounds that have risen to the highest levels, on mainly individual efforts, that have brought fame to this little rock. And make no mistake about it, they have done it on their own, and with individual help. It has been without the support of government or much corporate support. In fact, the distinguishing company that has supported sports consistently in Jamaica is really an Irish company, Digicel. Not that there are no other companies, Digicel stands the tallest amongst all others.

Don't be fooled though, those that have never supported sports, or any individual athletes, will sooner than later now hop onto the "Wagonist Express" and will make the most noise. I remember as a teenager listening to Bob Marley and Shabba Ranks, when many still thought that this was not acceptable music. It wasn't until late in the life of Bob Marley and after Shabba received international fame that many started to listen. We always seem to be the last to recognize what is the best of Jamaica because of our "Foreign Mind" mentality. We should be Americans as we believe if the person comes from America, or the product is made there, then that is superior to a Jamaican person or product.

Sure we have celebrated the achievements of our athletes and musicians over the years. But that is only after they have made a mark internationally, and been recognized by the world. As a country we never seemed to have the ability to recognise greatness before it hits the international stage, and rely on the endorsement of foreigners as if we suffer from a deep-seated inferiority complex.

If we are to move this country forward though, we cannot only be calling for the levelling of the playing field re drug use in athletics, but must also seek to level it for all Jamaicans in Jamaica. The most important capital we have is our people. In the information age, which started in the 1970s, it is well understood that knowledge is the greatest capital for any country's development. In Jamaica, however, we believe that every other country's knowledge is more important than our own. So over the years we abuse the rights of Jamaicans, and expect them to be silent. We use foreign expertise instead of building our local expertise, even though we can safely say that over the decades of doing so our country has gone from bad to worse.

Jamaica first
It is as if we do not have much regard for our most important capital component, Jamaicans. It is not the foreign investments that will really move this country forward, but the investments made by Jamaicans. Local investments are more committed to Jamaica's development, and more importantly profits, move back into the country rather than go out. This was a point made by Michael Lee Chin, that he is committed to invest NCB's profits in Jamaica, and not ship them out. The logic is simple: if one does not reinvest profits in the country, then the only thing that will happen is that the investments will be equal to the cost. If the investment is equal to the cost then there is no new development, and growth is stymied.

I will give some recent examples of how we treat Jamaicans:
. A few weeks ago at the airport, I was going on an early morning flight. Now most people will know that the airport is very busy at that time. On approaching the security checkpoint going to Immigration, I noticed a very long line waiting to go through security. I noticed that only one of the three security checkpoints was open. I thought how inefficient is it that the management did not ensure that enough people were at work at that time? To my surprise I saw some of the people who were standing there in blue uniforms, open another checkpoint and say they were only going to open it temporarily. I could not believe that they had the audacity to do so and watched as Jamaicans lined up like cattle. Surely it would not happen at Montego Bay where the tourists arrive;
. The explanation by JPS as to why people were overcharged on their bills and that it will be sorted out in the following month. Billing someone more than they are liable for, and expecting them to pay because they do not have a choice, is wrong. Maybe we could apply their own ad and say "If forcing someone to pay more than they owe is stealing, how come it is done. How come?"; and
. Recently Dr Gomes was on radio saying that while in her office policemen entered and took away a young man, while concealing their badges, and without showing any warrant, although requested.

And then when Jamaicans are aggressive we ask the question, why are Jamaicans like that? The answer is simple; this is because for years we have trained Jamaicans to be like that. If people have to wait in long lines, cannot get justice with the police or court system, or have to drive on bad roads, which they pay taxes for, then don't we expect a certain level of frustration from them? If people drive on the roads and see that it is those who break the road code that get to where they are going easier, then don't we expect that many will follow? Remember the laws of physics, for each action there is an equal and opposite reaction. If we treat people with no respect then we can expect the same results. But if we treat people with respect, just as other countries treat their citizens, then we can expect good to come from them. If we want Jamaica and Jamaicans to develop, then we must give them opportunities and preference over imported people or goods. By all means if they fail then they must be held accountable, but accountability must be based on objective and not subjective factors.

If we are serious about the development of this country, then we must understand that it cannot be done without the development of the people. It is said that capitalism is the most successful economic system of all time but it is not just because of the competitive market but also because it goes hand in hand with democracy. If we look at the most successful capitalist systems they all have in common the development and respect of their citizens as priority number one.

Friday, August 22, 2008

Wrong call on sugar estate

I really hadn't planned to write anything on the sugar deal, as I am not very familiar with the agreement and divestment process. But after being encouraged to do so by some members of the public, I felt compelled to set the facts straight on the financial analysis surrounding the company, Infinity Bio-Energy (IB), not because I hold any brief for them, but because I think the message being sent from the analysis is incorrect. And I believe that it is necessary for proper information to be communicated to the public.

I don't believe that there was any wilful attempt to mislead the public but rather, there might have been some amount of misguided "exuberance" to follow what was written in Businessweek. I myself haven't read the article, and don't think I need to, as I find that in many instances our own Jamaicans analyse situations in a far superior manner to anything done overseas. We only have to look at the record of organisations like the IMF and also the fact that the US, with all its glorified analysis, had significant economic fallout caused by their inability to properly assess the effects of irresponsibly created securities.

As an accountant, I am also fully aware that our own accounting standards are superior to US GAAP. And I think I am qualified to say that, having completed the Master's in Accounting at UWI and the CPA in the US.

Incorrect analysis
The article that seemed to unnecessarily cause quite a stir in the media about the "sourness of the sugar deal" was, in my view as an accountant, a misleading, superficial analysis. It was suggested that IB has solvency problems, based on two points, namely (1) that they reported losses on their income statement; and (2) that the current ratio at March 31, 2008 stood at 0.8.

While this analysis may be prudent for someone comparing investment options for getting the best returns, or doing a review of management's performance, it is ill-conceived in my view to apply the same analysis to determine whether a company is capable of long-term success or not. And especially when the current operators of the sugar company (government) was doing nothing more than pumping taxpayers money in for political rather than economic reasons. I think everyone will agree that it is in the best interest of Jamaica to diversify these loss-making assets, as the poor taxpayers just cannot afford to continue in this vein.

Nor do I think that we can use the excuse of the past botched divestment transactions as a reason against the current efforts. Those divestments, I would agree, failed because the responsible persons at the time failed to prudently complete the divestment process, and as Jamaicans would say, "Don't use your fat to fry somebody else."

When one is trying to divest an asset, it is naïve to look only at the profitability of the company. And in fact, accountants today have long recognised that value in a company is better discerned from the balance sheet, as the income statement (which records profit/loss) is just a measurement of activities over the past year. In fact, whether a company makes a profit or loss does not determine the company's solvency. If we want a good indication of a company's solvency, then we must look towards the balance sheet and cash flow statement.

It is apparent to me that the Businessweek article was done by a non-accountant. I say this because no mention is made of the most important statement of any audited accounts, which is the Audit Report. This is the first statement that must be read, as it speaks to accuracy and any concerns, such as insolvency, of the institution being audited. If there was a solvency issue then the Audit Report would have pointed this out, as it has been doing in the Air Jamaica's financial statements for years. But of course one must go further to determine if insolvency is a possibility.

Balance sheet analysis
The statement that the current ratio is 0.8, when at least 1 is desired, is also irrelevant in this case. One could also look at the trend of the current ratio, which was 1.12 at March 31, 2007; 0.66 at September 30, 2007; and currently stands at 0.82. If one looks further into the current assets, though, one will see that the cash and cash equivalents actually moved from US$19.9 million in 2007 to US$34.6 million in 2008. In addition, the reason why the current ratio has decreased is because the interest on loans and borrowings has increased from US$18.5 million to US$90.2 million year over year. This, of course, is an indication that money came into the company through loans, and sure enough, if one looks under non-current liabilities you will see that loans increased from US$3.5 million to US$179.4 million. This is an indication that significantly more money has come into the company.

The company also has a healthy Equity Attributable to Shareholders of some US$419.5 million, up from US$278 million. Of this amount, over 75 per cent is represented by share premium, which increased by 50 per cent. This in itself is an indication that significant new resources came into the company over the period. The cash flow statement also shows that cash generated from operations moved from negative US$27 million in 2007 to positive US$54 million in 2008. This is a strong indication that the company's ability to generate cash is improving significantly. And as far as I know, companies never go bust because they make losses but rather because they have negative cash flows. Overall, the company managed to increase cash and cash equivalents by some US$14 million.

These numbers show that (1) the company is in no way insolvent; and (2) it obviously has the ability to generate cash. In addition, when one assesses an agricultural company it is important to look at the long-term prospects because of the nature of the business. Naturally an agricultural company invests up front more in long-term assets such as biological assets, goodwill and plant and equipment. It is always a healthy sign when a company can access long-term financing, and also invests in long-term assets, as one can almost be guaranteed of not only future earnings but also that lenders have faith in the long-term viability of the company.

It is always expected that companies in the agricultural sector will face losses in their first few years or so of operation as sugar cane, like other crops, do not grow overnight. Any expectation of immediate profitability must be because over the last 15 years or so we have developed an economy with a trading mentality and so expect immediate profits. The investment by IB is obviously a move to invest in the long-term productivity of the country, which will add to the quality of growth rather than growth based on construction and trading, to which we have become accustomed.

There is, of course, a lot more analysis that can be done on these financials, but space does not permit a full-scale analysis. In addition to the fact that it would take more time, which I don't think needs to be dedicated further.

If we are really concerned about the viability of the sugar deal, where we should be looking is at the expertise IB carries and the terms of the contract. The attempt to use financial analysis to say that the divestment to IB is faulty, can only be seen as a misinterpretation by persons not fully cognisant of financial statement analysis, and should not be taken seriously. If one is sick, then it is important to seek the assistance of a qualified doctor. Similarly, financial statement analysis must naturally be left to qualified accountants.

Friday, August 08, 2008

What price for oil?

Since last year Jamaica has been suffering under the pressure of escalating oil prices. Only last September oil futures were selling for less than US$80 per barrel (bbl). Less than one year later (July 2008) oil was selling for a record US$148/bbl, which is an increase of 85% in 11 months, rivaling any Cash plus returns. This week oil fell to below US$120/bbl and the world is breathing a sigh of relief. That’s amazing given that only last year it seemed ludicrous that oil would be trading over US$100/bbl.

The steep and rapid increase in oil prices has caused much economic hardship across the globe, as countries try desperately to cope with this essential ingredient of production and everyday life. Even rich countries such as the US have seen declines in real income levels, as consumers find it difficult to adjust to both rising energy and food prices.

Was there an oil bubble?
The recent fall off in oil prices have caused many to say that the rise in oil prices was a bubble waiting to burst, and sooner or later oil will fall to below US$80/bbl again. There are of course an equivalent amount of persons who believe that the recent fall off in prices is just a temporary reprieve in the inevitable climb of oil to even newer highs in the future. Even if oil falls off though, it is clear that we may never get back to US$30/bbl oil, and this means that countries like Jamaica must find more efficient means of energy.

These alternatives will of course include finding cheaper energy sources, and more importantly changing our consumption patterns, as it relates to energy. This however will necessitate infrastructural and cultural changes if we are to move forward. To compete internationally we will have to find cheaper energy inputs for production also.

The important question for the short term, however, is where will the price of oil end up? Is it that the run up in the price of oil was just a bubble that inevitably would have popped, or is this just a temporary ease, as consumers change their consumption patterns? The real issue still remains one of demand and supply in my view. Will there be an adequate supply of oil in the future to match the expected increased demand.

Before I look at where the price of oil will end up, I would like to briefly examine what are some of the underlying reasons for the recent fall off in the price. It is important to understand this if we are to determine what the future holds for oil prices. In March 2008, when oil was at US$105/bbl, I wrote that by April/May I expected oil to go above US$120/bbl. After that was achieved, on a radio interview I said that oil would spike to US$150/bbl and then drop off. The extent to which it fell off would depend on how quickly the price went to US$150/bbl, as if it gradually climbed there around November/December 2008 it would have continued rising. The fact that it went to US$148/bbl in July 2008 was good, as it meant that the fall off in price was going to be more violent.

The fact is the rapid rise in price to US$148/bbl in such a short period was unsustainable. What happened in more efficient markets, such as the US, is because prices moved up so quickly, income levels were unable to cope with the quick rise and so the reaction was to move to mass transit and cut down on discretionary driving. In addition the Olympics also helped, as in trying to clean up the air pollution China mandated that half of the cars usually on the roads, would have to be parked each day leading up to the Olympics. Also during August many traders usually go on vacation. The fact therefore is that the fall off in oil price was as a result of reduced demand globally.

Technical analysis
From a technical point of view, the chart shows the long term movement of the price of oil. It clearly shows that the long term trend of oil is still bullish; meaning over the long term it still seems set to rise. In addition the bottom chart shows that the declining price is losing momentum.

What this means is that the threat of rising oil prices is still very much present. Oil could very well hit the trend line support between US$110/bbl to US$120/bbl and bounce back up to the highs or beyond. This would signify a sharper increase than if it hits the longer term trend line support between US$100/bbl to US$110/bbl, which would mean a more gradual price increase. If oil fails to take out the high on any bounce this would be a good sign.

In order for oil to settle at US$80/bbl or below it needs to close below US$90/bbl. Only then would there be any hope for the threat of rising oil prices receding. Even the shorter term chart is showing that at the current price (approximately US$120/bbl) it is showing that oil is oversold and it could easily bounce back if some buyers started to enter the market.

In my view then, even though oil prices have fallen off significantly there is still no fundamental change in longer term factors that will definitely keep the prices down. The following factors may still continue to place wind behind the wings of oil prices:
-The US economy still shows uncertainty that can continue to cause US$ weakness. I expect this uncertainty will continue until at least the end of the third quarter;
-After August traders will come from vacation and could add to the market demand for oil futures (or could increase the down momentum);
-After the Olympics the full complement of cars may get back on the roads in China. And if the US economy starts to show some strength, going into the 4th quarter, then people could start driving more and taking vacations again. Additionally, the longer term demand could drive speculation that demand will outstrip supply;
-Iran does not seem serious about disbanding their nuclear program, and this could lead to increased geo-political concerns about supply; and
-The technical analysis shows that oil price could be well supported between US$100/bbl to US$120/bbl.

The irony is that world economic weakness is actually a help to reduced oil prices, as demand for oil will be lessened. What is clear though is that for the foreseeable future oil will still remain relatively high, when compared to former years, and will still be a significant burden for countries like Jamaica. If we do not act in the short to medium term to address our energy costs then we will become less competitive in a declining world economy, which is double grief.

Friday, August 01, 2008

The danger of paper profits

The unregulated financial organizations (UFOs) have one after the other stopped paying out monthly amounts to participants, starting with Cash Plus last year. What is even more evident is that many of the over 20 UFOs, identified by the FSC, seems to be “genetically” linked, leading to the collapse of many at one time. This no doubt has led to significant fall off in the income levels of many Jamaicans, and will no doubt affect industries such as the motor vehicle and real estate sectors.

I have been speaking with some people who have been severely affected by the fallout, as many have not only placed the great majority of their savings in these schemes, but also borrowed money to secure assets based on the income flow they expected to continue in perpetuity. The decision to rely on “risky” investments to maintain a lifestyle of course is one grounded in stupidity, as even if a risky investment is legitimate the fact that it is such a high risk means that one cannot prudently expect it to continue forever.

Foreign currency trading
I have always indicated that foreign currency trading is a well established trading activity, and people do make significant returns from trading currency. Within the global context, foreign exchange trading accounts for over US$2 Trillion traded daily, and is much larger than any single traditional investment type. On the other hand I have always been at pains to point out that there is a high degree of risk associated with this type of activity, and just as one wins big, one can lose big also. So even if high risk investments are regulated in many instances they will make huge losses and go out of business, causing much pain to those who have invested. In fact one legitimate hedge fund in the US last week reported that it was going out of business as it had lost some US$3.2 billion on oil longs when the price of oil futures significantly fell off.

There are of course methods that can be used to minimize losses but on average a hedge fund may last for around five years and then usually suffers significant losses because of its risky nature. The lesson though is that anyone who significantly upped their lifestyle based on risky returns should not only see a psychiatrist but also a neuro surgeon to see what part of their brain was not functioning when they made that decision.

The bigger picture for Jamaica though is that these returns were nothing more than paper profits. And the problem with paper profits is that there is no productive asset to back it up, so what it creates is a fall sense of wealth for the country with no productive base. As a country this is not a strange phenomenon for us, as in the 1990s because of a high interest rate policy we did create a “paper profit” economy also, which effectively killed the productive sector, and on its way helped to create that monstrosity we call FINSAC.

What paper profits do is that it creates a notional return that cannot be backed by the creation of any goods for consumption. So wealth is created by means of money on paper, and is unsupported by an increase in assets, which eventually leads to inflationary pressures. When these inflationary pressures are created it has the effect of either pushing up prices or in order to keep prices stable we will have to either (i) push up interest rates; (ii) borrow money to be able to buy more goods for consumption; or a combination of both. So when paper profits were being created by high rates of interest on government paper in the 1990s in order to prevent the inflationary pressures from pushing prices up we borrowed money to create an illusion that there was real stability when all the time we were only setting up ourselves for the pain that comes with debt repayment. This was not the result of any unregulated scheme, but was the design of legitimate government policy, which had the same effect as the collapse of the UFOs. The only difference was that in the 1990s taxpayers bailed out those that would have lost their investments and today those that invested directly will lose out.

Pyramid economy
So in the 1990s we created a regulated “pyramid economy”, which we are still suffering from today. The following simple example shows the effect that paper profits have on the economy.

1) Assume that the value of goods in the economy is at $100 and income levels are at $100, then there is a 1:1 relationship between goods and income.
2) We can also assume that the savings rate is 20%, so that $20 out of the total income of $100 is in savings accounts and $80 is used for consumption. So that the relationship between goods and income is $80 divided by $100, resulting in each unit of good being valued at $0.80.
3) If one invested in a piece of paper (government instrument or UFO) paying 10% per month, by using the savings of $20, then you would theoretically generate an additional $2 per month, and in a year one would generate an additional $24 of income ($2 times 12 months using simple interest for ease of calculation).
4) If this additional $24 goes into consumption then consumption income increases to $104.
the effect of this is:
a) The price of goods goes up, as no new goods are produced, as the returns are just based on paper profits. So price per unit moves from $0.80 to $1.04 ($104 / $100). In contrast if $24 worth of goods were created price would only go to $0.83 each.
b) There is no new investment in the economy as the savings, which in economics equals investments, is gone into paper.
c) Because the investment is in paper then what is being used to pay the investors are the savings of $20 and in addition $4 must be borrowed by the government or the pyramid to pay the investor. This will mean getting new monies in from new entrants, who are outside of the economy as the entire income of the country will have been used in consumption.

It is this effect that helped to create the financial crisis in the economy in the 1990s and that contributes to inflation, low productivity, and low economic growth. The positive from the fallout of the UFOs is that inflationary pressures will be eased, as the price of items such as motor vehicles and real estate will fall, as the total income falls and more goods are now available for consumption as the secondary market for goods grow. What it also means though is that growth will be negatively affected (the quantum to be determined) as there is less savings for investment purposes.

This dilemma is at the heart of Jamaica’s problem. It is the inability to grow productivity that has caused the lack of economic growth. In fact what we have seen is that productivity has been declining. Unless we can turn around this problem then there will be no meaningful growth and creation of real wealth. In the immediate future, with current global conditions, and our own local situation, the best bet for us is to reduce consumption activities especially in relation to energy. This of course means that fiscal measures will have to be a key ingredient of our near term economic strategy.

Friday, July 25, 2008

The high cost of crime

For years now, we have known as a country that crime is the most significant factor contributing to the lack of economic growth in Jamaica. And this is not only crime as it relates to murders, robberies, and rape, but includes white-collar crimes such as corrupt activities by public officials. The fact is that crime contributes significantly to the cost of doing business in Jamaica and hence decreases productivity, which is at the heart of our economic challenges.

This effect is even more pronounced now, as the world is caught in a serious downturn in economic activity. Because of this, the region as a whole is expected to experience negative impacts to tourism and remittances, the mainstay of Caribbean economies. The IMF has reported that world economic growth is expected to decrease from five per cent in 2007 to 4.1 per cent in 2008 and 3.9per cent in 2009. The Latin America and Caribbean (LAC) region has not been spared, and growth is expected to slow from 5.6 per cent in 2007 to 4.4 per cent in 2008 and 3.6 per cent in 2007.

Poor regional performance
So, the numbers show that the LAC region is expected to decline at a faster rate than total global growth. My view is that this is explained by the fact that Caribbean economies' main foreign exchange earners (tourism and remittances) are discretionary income types, and so the expected slowdown in consumer demand, and reduction in discretionary disposable incomes, will have a greater effect on the Caribbean. The exception, of course, being Trinidad that produces oil.

A March 2007 report by the UN/World Bank entitled "Crime, Violence, and Development: Trends, Costs, and Policy Options in the Caribbean", reveals that crime robs the region of a significant amount of growth. Murders per 100,000 population annually at 30, is the highest in the world when compared to other regions. It also states specifically that if Dominica, Guyana, Haiti, and Jamaica were to reduce their annual homicide rates to Costa Rica's level they could add 1.8 per cent, 1.7, 5.4, and 5.4 per cent respectively to their annual growth rates. In the case of Jamaica, this comes against the background of a 2003 study which found that crime costs the country 3.7 per cent of annual economic growth.

So, because we have failed to act for so long, the cost of crime has continued to increase. This is evident in the last business confidence survey, which shows that less business persons are inclined to put new investments in Jamaica. No doubt, all the evidence points to crime as the number one problem in Jamaica today.

The question then is, how can we deal with this problem? All we have been doing over the years is just talking and putting in place the same old policies over and over again. Whenever we have an upsurge in crime, we tend to put in place 'tough' measures to fight the monster. This always elicits the same response from human rights groups and the police go out and crack a few skulls while their actions contribute even more to the increasing levels of crime, because what they do creates enemies instead of deterring crime. In fact, the same UN/World Bank report states: "An important finding. is that in Jamaica a lower percentage of crimes are reported to the police in areas with higher crime rates. The reporting rate can plausibly be interpreted as a measure of confidence in the police, as people will be more likely to report when they trust the police and believe they will respond. Lack of trust and confidence in the police is then lower in areas with higher local crime rates."

Chasing the wrong issues
This, in my view, is at the heart of the crime problem we face. And so, when the media continues to focus on the measures announced by the prime minister, this is another example of how way off track we always are in what we need to focus on. The prime minister has announced extended detention measures (when properly approved) and mandatory prison sentences for certain crimes, amongst other measures. As far as I am concerned, extended detention has always been practised unlawfully by the police and some have always imposed their own sentences on citizens without a trial. The announcements by the prime minister will not, in my view ,further erode the rights of Jamaicans as they have always been subject to the whims and fancies of the police. In fact, if the appropriate controls can be put in place, the measures announced by the prime minister may even improve the conditions.

The important thing to focus on is not the measures announced by the Prime Minister. If these measures can be properly controlled, then the best way to avoid being subject to them is to not commit the crime. This reminds me of when, under the previous government, motor vehicle fines were significantly increased and there were demonstrations against the fines by some taxi drivers. As far as I am concerned, the way to avoid the fines is to stick within the rules.

If we are to seriously deal with the crime problem then it is not enough to give greater powers to the security forces, which are needed in the short term to address the crime crisis. Giving the police additional tools is like giving the carpenter a saw and hammer to make a table. If the carpenter is not competent, then despite all the high tech tools he may be provided with, the table will still not be made properly. And so we need to go beyond the measures announced by the prime minister and address penalties for police corruption; how we intend to build trust in the police force; and what immediate improvements are to be made to the justice system.
The fact is that no new powers for the security forces can work without people trusting the police, and feeling comfortable giving them information. If people feel that the police are their enemies then they will never come forward with information. We also must remember that justice delayed is justice denied, and prolonged court cases while the legal fraternity argues about who are hustlers and who are not is just not cutting it. And very importantly, we must double the penalty for public officials involved in corrupt practices. It is only after we address these issues that any measures we implement will work.

The fact is that, as a country we cannot afford to continue the high levels of crime that have haunted us for far too long. The effect has been compounded by world economic events, as rising energy and food prices mean that businesses are less competitive and real disposable income levels have decreased. But as we seek to solve the crime monster, let us not lose focus of what the real issues are.