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.