Archive for October, 2010

The Best Central Banker Ever?

Tuesday, October 26th, 2010

Recently I had the pleasure of attending a session with Paul Volcker, the former Governor of The US Federal Reserve (1979-87), along with about 2,000 other Toronto financial types. Mr Volcker is now in his 80s, but his 6 and half foot frame is still pretty erect and his mind and sense of humour as sharp as ever. He began by remarking that his predecessors in this series of distinguished speakers in Canada had been Bill Clinton, Tony Blair, Alan Greenspan (“several times”), George W Bush and lastly Sarah Palin. “You may notice a trend in the attitude of the speakers towards government intervention” he drolly remarked “which I would disassociate myself from. While I think it’s fair to say the latter speakers probably disapprove of government, I believe in government intervention, in the right areas.”

He went on to make case for increased government control and regulation of the commercial banking industry. While at pains to avoid direct criticism of his successors (“it’s not appropriate for me to comment on the conduct of monetary policy”), Mr Volcker made the point, as he had done elsewhere as senior adviser to President Obama, that if commercial banks received government guarantees of their deposits, then they should not be permitted to use their balance sheets to speculate. This had led to problems of moral hazard that had caused the financial crisis of 2008-09, where management of universal banks had been willing to take on risky financial exposure through Credit Default Swaps (CDS) and other derivatives, most of which, it was plain from his comments, he believed that they had failed to understand. Of course, Mr Volcker has famously remarked that the only useful financial invention of the last 30 years is the ATM, so it was unsurprising to find him unenthusiastic about the growth of opaque financial instruments. He had no problem with investment banks using their balance sheets and capital to speculate and make markets, as long as they were allowed to fail if they got it wrong, and didn’t cause systemic risk to the world banking system, which is what had happened with commercial banks being allowed to participate in such activities.

In essence, Mr Volcker seemed to be advocating a return to the separation between commercial and investment banking required by the Glass-Steagall Act of 1934, which had been abolished in 1998. The Financial Reform measure that the Obama administration had introduced this summer supposedly prohibits the universal banks from using their capital to invest in hedge funds and derivatives of most kinds, but as always, the devil will be in the details of enforcement. It is astonishing that some of the same managements that led the major banks into the present crisis are still largely in place and paying themselves enormous bonuses once again. Asked by moderator Don Drummond, Senior Economist at TD, about some banks being regarded as “too big to fail”, Mr Volcker did not disagree with the principle. He pointed out that the utility functions of banks, such as cheque-clearing and payment systems, as well as being able to extract cash from ATMs, required that the bank networks remain operating to allow commerce to continue. It was evident that he didn’t think that meant the commercial bankers needed to pretend to be Goldman Sachs and pay themselves accordingly.

In a passing comment, Mr Volcker remarked that it was remarkable to hear central bankers complaining about inflation being too low. “We know how that movie ends” he said.

When Is The Next recession Due?

Wednesday, October 13th, 2010

The National Bureau of Economic Research (NBER), the body of eminent economists which decides when the US goes into and comes out of recession, undoubtedly has the best job in the world. After all, I would love to be able to make my decisions with the benefit of hindsight, as the NBER doesn’t make up its mind until between 12 and 18 months after the economy has changed direction. Thus it took until December 2008 for them to tell us what everyone had known already-i.e. that the recession began in December 2007, and they announced last month (September 2010) that the recession had finished-in June 2009! Incidentally, the official definition is NOT 2 consecutive quarters of negative GDP growth, but includes a range of factors including earnings, industrial production and inventory changes.

It would have been amazing if there hadn’t been a recovery in the second half of 2009, given that the 2007-09 downturn was the most severe in the post war era; just not shrinking at the same rate was sufficient to produce 3-5%p.a. GDP growth. Now that the year-on-year comparisons are with the second half of 2009, when the economy was growing at 3% on an annual basis, achieving reasonable growth becomes much more difficult. Also, a lot of the second half growth last year was due to government one-off stimulus measures, such as “cash for clunkers” in the auto sector, and the first time home buyers credit, which originally was due to expire in October 2009. Now that these are no longer in place, growth is dependent upon private demand, which has remained very subdued with unemployment still at 9.6% (or 16.5% if one takes the broader definition which includes discouraged workers who have given up looking for jobs for more than a year). David Rosenberg at Gluskin Sheff has estimated that auto production in the third quarter 2010 will have added over 1.5% to US GDP, as GM and Chrysler were essentially shut down in the same quarter last year after filing for bankruptcy in Q2 2009. Excluding this boost, US GDP growth will be under 1% annualized. No wonder the Fed is contemplating restarting Quantitative Easing again.

The Best September Performance in 71 Years

Friday, October 1st, 2010

At the close of business today, September 30th, 2010, the US stock market indices were up the most in percentage terms since 1939, with the Dow Jones Industrial Average up 7.7% for the month, which was also the largest point gain since October 2002, the bottom of the tech wreck bear market of 2000-02. The broader S&P500 Index was up 8.8%, and the Nasdaq a remarkable 12%. Meanwhile, European bourses were also strong, with the UK’s FTSE100 and French CAC40 both up 6.2%, and the German DAX up 5.1%. In Asia, the Hang Seng Index in Hong Kong rose 8.9%, and the Nikkei225 6.2%, although the Shanghai Index only rose 0.6%.

However, despite much talk of the worries about a double dip recession being avoided in the US, and commentators explaining the rise being due to the anticipation of strong earnings growth, it is hard to get too enthusiastic about the developed markets’  markets’ performance. Year to date, the Dow Jones is only up 3.5%, the S&P500, 2.3% and the Nasdaq 4.4%, so at the end of August, all of them were down for the year. The FTSE100 is only up 2.5% and the Nikkei225 is actually down -11.2% YTD. Ironically the best performing major market by a short head is the S&P/TSX Composite, whose laggard 3.8% rise in September still leaves it ahead of the field , up 5.3% YTD. With the best fiscal position in the G-7 economies, all of the 400,000 jobs that were lost in the sharp recession of 2008-09 regained, and house prices up 12% over the last twelve months, it’s no wonder that the Canadian economy’s healthy performance is being reflected to some extent in its stock market. More importantly, given that half the TSX index is comprised of resource and energy stocks, the continued demand from emerging markets for Canada’s raw materials is helping to offset the weakness of the US economy, traditionally the most important factor for the Canadian economy.