Viable Opposition

Canada debt

2012-01-19T16:03:00.001-04:00

http://www.td.com/document/PDF/economics/special/ca0112_personal_debt.pdf

Canada's Oil Sands: Are We Exporting Canada's Energy Security?

2012-01-18T19:55:00.000-04:00

Now that the Keystone XL pipeline project looks like it’s future is up in the air, I thought that it was timely to take a look at a recent paper by J. David Hughes of Global Sustainability Research Inc. entitled "The Northern Gateway Pipeline: An Affront to the Public Interest and Long Term Energy Security of Canadians". This paper provides an interesting look at the rationale behind the building of the Northern Gateway Pipeline (NGP). To assure you that Mr. Hughes is qualified to speak on the issue, he was employed as a petroleum geologist for the Geological Survey of Canada for 32 years.

For those of you who aren't aware, the NGP is a twinned pipeline being being proposed by Enbridge to move 525,000 barrels of diluted bitumen sourced from the oil sands projects in Northern Alberta to Kitimat, British Columbia and 193,000 barrels of condensate per day from Kitimat to Edmonton where it is used as a dilutant for the lower gravity synthetic crude. This pipeline will function as competition for the proposed TransCanada Keystone XL pipeline to the United States Gulf Coast. Kitimat, through their connection to open water via the Douglas Channel, is currently handling tankers carrying petrochemicals and will likely serve as a launching point for diluted bitumen as it is shipped to China.

Here is a summary of the project:

Here is a map showing the route of the pipeline:

Construction of the 1177 kilometre long, $5.5 billion pipeline is expected to commence in early 2014 with completion and commissioning of the project by the end of 2017. Enbridge rationalizes the economics for construction of this project on their forecast of a tripling of oil sands production by 2035. The paper by David Hughes refutes the need for the NGP based on more realistic production forecasts and expresses concerns about the future of Canada's energy independence as increasing volumes of oil are proposed for export. In his paper, he also outlines the environmental concerns that must be taken into consideration over the route of the proposed pipeline, but I will not address those issues in this posting, rather, I will focus on the rationale behind why Canada should retain its own finite supply of energy resources rather than accelerating exports to other nations.

Mr. Hughes opens by outlining several problems with the reasoning behind the Northern Gateway Pipeline project:

1.) The current and planned export pipeline infrastructure is sufficient to handle the production from both existing and under construction oil sands projects. Even with the future development of unannounced future projects in the Canadian Association of Petroleum Producers (CAPP) growth scenario, export pipeline capacity is sufficient through to 2025.

2.) Canada is a high per capita consumer of oil and a significant oil importer, importing 780,000 BOPD in 2010. By committing to accelerated exports of oil, Canada's long-term energy security is under potential threat.

3.) The NGP is predicated on unreasonable oil sands production growth rates. Under CAPP's optimistic forecast, the supply of oil sourced from oil sands will increase by 152 percent between 2010 and 2025. Enbridge has used an extended forecast out to 2035 in which they project oil sands supply growing by 217 percent by 2035, an unreasonable level given the environmental, social and emissions impacts of tripling oil sands production not to mention the massive capital expenditures required to increase production to those levels.

4.) Accelerated liquidation of Canada's finite oil supply is not necessarily in the best interest of Canada's energy future, particularly in light of the fact that it appears most likely that the world is either at or very close to peak cheap oil.

As I stated earlier, for the purposes of this posting, I'd like to focus on Canada's present and future oil needs and the likelihood that Canada may well need its own oil in the future as domestic consumption rises and production falls.

Let's start out by looking at how much oil Canadians consume. Canadians are among the world's highest per capita users of oil at 24.6 barrels of oil per person per year for a total of 1.75 million barrels of oil per day, more than five times the world's per capita average, even exceeding the per capita usage level of the United States. Here is a graph showing Canada's daily consumption of oil by product:

Canada's conventional oil production peaked in 1973 at roughly 2 million BOPD. Current growth in oil production is sourced strictly from both in situ and oil sands mining, accounting for 51 percent of Canada's 2.86 million BOPD in 2010 as shown on this graph:

Canada is a vast country and its oil wealth is not evenly distributed across the nation with the vast majority of oil and natural gas reserves being located in Southern Saskatchewan, Alberta and Northeast British Columbia. This means that while the western parts of Canada are producing oil, the eastern provinces are forced to import oil for their needs. Here is a chart showing the total volumes of oil imported and exported between 1989 and 2009 in thousands of cubic metres (one cubic metre of oil equals 6.289 barrels of oil):

Notice that annual imports of oil have risen in concert with the rise in exports to the United States.

Here is a graph showing the net oil imports and exports by province over time:

The provinces in Atlantic Canada and Quebec rely on oil imports for 100 percent of their consumption needs and Ontario is approximately 13 percent dependant on imported oil. As it becomes increasingly apparent that the world's oil production levels cannot possibly grow indefinitely, the eastern half of Canada becomes increasingly vulnerable to the geo-political forces (i.e. OPEC which supplies 50 percent of Canada's imported oil) behind oil pricing and supply.

What should be of additional concern is the projected growth in Canada's oil consumption. As shown on this graph, forecasts show that Canada's oil demand will increase in a range from 2.25 to 3.05 million BOPD by 2030:

This is particularly worrisome in light of Canadian Association of Petroleum Producers’ (CAPP) projections for future oil production showing that production of conventional light, medium and heavy crude is expected to fall significantly by 2025 with the only growth expected in the production of synthetic crude and bitumen. According to CAPP, summing the production from all existing and under construction oil sands projects and the remaining conventional crude production results in peak oil production of about 3.6 million BOPD in 2018 as shown here:

This projection assumes that oil sands production will grow by 50 percent from 1.47 million BOPD in 2010 to 2.28 million BOPD by 2019. Using CAPP's most over-the-top forecast of 152 percent increase to 3.73 million BOPD requires the development of an additional 1.5 million BOPD of highly speculative new oil sands projects. This scenario is hard to imagine, particularly given that it has taken since 2000 just to grow production by a mere 800,000 BOPD at a cost of $91 billion.

To give us a sense of the time involved and cost of a major oil sands project, let's take a brief look at one of Canada's most recent surface mining oil sands projects, Canadian Natural Resources' Horizon Oil Sands Project. As a disclaimer, a member of my household actually worked for CNRL; this company is extremely effective at squeezing efficiencies out of every last dollar that they spend and they have been a rather spectacular Canadian oil company growth story. CNRL's Board first gave approval for the building of the Horizon project in early 2005 after several years of planning. Construction began in the second quarter of 2005 and the project was commissioned and producing its first oil in early 2009. The final cost of Phase 1 of the project reached $9.7 billion, up 43 percent from the original estimate of $6.8 billion. Phase 1 is designed to produce 110,000 BOPD of sweet synthetic crude oil at a cash operating cost of between $36 and $43 per barrel in 2010. Additional investment in future phases of development are expected to bring Horizon's ultimate capacity to 500,000 BOPD and construction will take place in several stages. CNRL's Board has approved 2012 capital expenditures at Horizon of approximately $2 billion in the steps necessary to bring production up to the 250,000 BOPD mark in the next few years. You will notice that the company is committing very serious money to bring just 250,000 BOPD of additional synthetic crude on the world market. This puts into perspective the massive funding that would be required to bring CAPP's most optimistic forecast of 3.73 million BOPD of oil sands production onto the market. Interestingly enough, a January 2011 coker fire at the Horizon plant is estimated to cost between $350 and $450 million to repair and has set the project behind, showing the risks involved in oil sands operations.

We all hear that Canada has one of the world's largest oil reserve bases, third only to Saudi Arabia's massive conventional oil reserves and Venezuela’s combination of the two. In sharp contrast to Saudi Arabia’s conventional oil resource, oil sands are a very high cost, low return resource. The value of an oil resource is measured using a parameter called Energy Return on Energy Invested (EROEI). In the case of conventional oil, EROEI averages about 20 to one (i.e. you get 20 times the energy for every unit of energy used to extract and produce the resource). In the case of mineable oil sands, the EROEI is roughly 5.7 to one and in the case of in situ oil sands, the EROEI is roughly 3.8 to one. This is largely because of the large amount of energy needed to mine the sand and upgrade the bitumen, most of which is supplied by natural gas. This is where the large greenhouse gas footprint of oil sands enters the equation.

As well, while the oil sands reserves are immense, they are not infinite. Of the 169.3 billion barrels of reserves reported by the Alberta government, roughly 80 percent are not surface mineable, requiring the use of more energy-intensive Steam Assisted Gravity Drainage (SAGD) in situ technology. The remaining established reserves under active development, estimated at 26 billion barrels, could be exhausted after just 19 years of production at CAPP's most optimistic 3.73 million BOPD rate. To date, 24 percent of Canada's oil sands under active development have already been consumed. When this is totaled with the already consumed conventional crude, 51 percent of Canada's total oil reserves have already been produced. As would be expected and as has been experienced throughout the history of oil production and exploration, the oil industry is exploiting the most easily produced resources first with the less profitable resources being left behind for future exploitation. With bitumen saturations varying from 1 percent to 18 percent, there is quite a wide variation in resource value. These remaining oil sands resources will be more costly to extract and will have a lower EROEI than what the industry is experiencing now. A perfect example of this is the move toward exploring for conventional oil reserves in more remote and hostile environments including Canada's east coast offshore and Canada's Arctic where both operating costs and geological risk are extremely high. Take it from my experience as a petroleum geologist, if there were an easier and cheaper way to produce oil, the oil industry would already be taking advantage of it.

Yes, we all know that China has an insatiable thirst for the world’s finite supply of commodities, particularly oil. Rather than rushing to export one of our most precious and critical domestic natural resources, perhaps it is time to form a long-term, exhaustive national plan for Canada's energy future, ensuring that sufficient resources exist for future generations of Canadians. Let's hope that we are not mortgaging our futures for the relatively short-term instant gratification of quick corporate profits for pipeline companies and the creation of a few transient jobs. We need to at least weigh the opinions of qualified researchers against those of politicians and Corporate Canada who have their own agendas that aren't necessarily in our long-term, best interests.

I hope that this posting will cause Canadians to pause and reflect on the value of our remaining energy resources. While I am not particularly a proponent of oil sands as an energy source, I think that it would be prudent to examine Canada’s future energy needs and make wise and informed decisions about the long-term ramifications of wholesale exploitation, both in terms of environmental and economic impact. At some point in the relatively near future, Canada's domestic reserves of conventional oil will be exhausted and we'd better have Plan B in place well before that happens.

The European Economy - Is It All Over But the Tears?

2012-01-17T07:30:00.000-04:00

Now that Standard & Poor's has, not surprisingly, downgraded the debt held by the EFSF, I thought that it is quite timely to look at a recent news release and speech covering the state of the European economy.

First, let's take a look at the report by the British-based Centre for Economics and Business Research (CEBR). In this news release, CEBR forecasts that, in Q1 2012, the United Kingdom economy is already in a recession and probably was in Q4 of 2011. CEBR has downgraded its previous forecast economic growth rate of 0.7 percent for all of 2012, a very tepid rate at best, to a decline of 0.4 percent. If Europe's problems are worse that it appears now (which they most likely are), CEBR projects that the U.K. economy will shrink by 1.1 percent over the coming year as shown on this graph:

Projecting forwards, CEBR expects growth of only 0.9 percent in 2013 followed by 1 percent in 2014, hardly stellar growth rates. United Kingdom unemployment is expected to increase to about 3 million people over the next 18 months, compared to 2.64 million or 8.3 percent of the workforce in October 2011. The most recently released data shows that the unemployment rate was the highest since 1994 as shown on this graph:

The CEBR also predicts that the Bank of England will undertake a further round of quantitative easing in 2012, bringing the total to £400 billion, up from about £275 billion in early 2012. This is all in an attempt to keep interest rates further along the curve low on top of keeping the base rate at 0.5 percent until at least 2016. Interestingly, as I posted here, at least one Federal Reserve Bank President feels that it is entirely possible that long periods of ultra-low interest rates may have the opposite effect on the economy than what is intended. Rather than stimulating growth through cheap credit, the lowered rates could be creating a Japanese-style "lost decade" with low or no growth and deflationary pressures, as has been Japan's experience after a decade of QE by the Bank of Japan. Perhaps this is at least partly to blame for the rather moribund U.K. economy as well as the rather tepid economic growth around most of the developed world since the "end" of the Great Recession.

With Germany releasing poor economic data last week, my suspicion is that we are in for a slew of grim economic growth figures over the coming quarters with constant revisions downward as we move forward.

On another note, David Lipton, First Deputy Managing Director of the IMF, recently gave a speech at the Asian Financial Forum entitled "Strengthening the Asia/IMF Relationship in a Highly Uncertain Global Environment". In this speech, he outlines how the issues facing Europe are posing a threat to the Asian economy. Before we take a closer look at Mr. Lipton's speech, I would be remiss if I didn't remind you that the IMF totally missed predicting the Great Recession, despite their ample arsenal of economic big thinkers as I posted here. By their own admission, they were caught in a classic case of clusterthink and allowed themselves to be lulled into a false sense of economic well-being.

Mr. Lipton opens by noting that several months previously, the IMF had warned that the global economy was entering "a dangerous new phase". The pace of global economic expansion is weakening, save that of the United States, largely because of the escalating Eurozone crisis. Banks are not lending and they are being forced to sell assets to clean up their balance sheets. Interest rates on sovereign bonds are hitting new highs for many European nations. These factors are now acting in concert, driving both European and global economic growth downward. As an aside, I find it most interesting that, while not the topic of his speech, he completely neglects to mention the rising level of United States federal government debt as a pending hindrance to world economic growth.

Mr. Lipton suggests the following solutions to all that ails Europe:

1.) More liquidity for both banks and sovereign nations.

2.) More fiscal consolidation (i.e. austerity measures) that does not impact short-term economic growth.

3.) More growth by putting more capital into banks to ease credit.

4.) More fiscal and financial integration to ensure the viability and stability of the Eurozone monetary union.

The ECB has already undertaken what could ultimately be a rather controversial step; they have dumped hundreds of billions of euros into the European banking system in an attempt to free up Europe's credit markets. Mr. Lipton also notes that Eurozone leaders have agreed on a mechanism to ensure that future fiscal discipline among Member States is maintained, although, a 3 percent deficit-to-GDP cap and a 60 percent debt-to-GDP cap have been in place since the inception of the Eurozone and they have failed miserably. Perhaps it is as Albert Einstein so famously said, "Insanity is doing the same thing over and over again and expecting different results.".

Here are the last two paragraphs of the first section of Mr. Lipton's speech:

"The stakes are high. Without bold action, Europe could be swept into a downward spiral of collapsing confidence, stagnant growth, and fewer jobs.

And in today’s interconnected global economy, no country and no region would be immune from that catastrophe."

Mr. Lipton assures his audience that the IMF is working with Europe to "restore market confidence, rekindle growth and ensure the integrity of the common currency.". The IMF will be making a case to increase their lending capacity to augment the resources that Europe requires to tackle its problems. The IMF is looking for a stronger partnership between Asian nations and the Fund (i.e. begging hat-in-hand for a "donation" to a very worthy cause) with Japan and China now being the second and third largest IMF shareholders overall, after the United States. With the 2010 plan to double the size of the Fund to $755.7 billion, the fine folks at the IMF will need all of the help that they can get from China and their multi-trillion dollar foreign reserves, in particular.

We should now all pause for a moment's silence and recall that it was the IMF who was largely responsible for the world's largest sovereign debt default back in 2001. Perhaps Europe's confidence in an IMF bailout is rather misguided but only time will tell.

Canada's Health Care System - An Unsustainable Burden

2012-01-16T07:30:00.000-04:00

Canada's Parliamentary Budget Officer, Kevin Page, recently released a note entitled "Renewing the Canada Health Transfer: Implications for Federal and Provincial-Territorial Fiscal Sustainability". In this note, the PBO analyzes the Government of Canada's (aka Harper Government's) December 2011 announcment that the Canada Health Transfer (CHT) would continue to grow at 6 percent annualy until 2016 - 2017 and then starting in 2017 - 2018, the CHT would grow in line with the three year moving average of nominal GDP growth (the escalator), guaranteeing a minimum of 3 percent per year until the CHT is reviewed in 2024. While all of these dates seem very far in the future, this paper looks at how these changes will impact provincial-territorial budgets. Coincidentally (or not), these changes just happen to be taking place within the exact time frame that baby boomers will be availing themselves of more health care system resources.

Let's digress for a moment. The much-abused Canada Health Act (CHA) states that its primary objective is:

"...to protect, promote and restore the physical and mental well-being of residents of Canada and to facilitate reasonable access to health services without financial or other barriers."

The CHA establishes the criteria that Canada's provinces and territories must fulfill in order to receive the full federal Canada Health Transfer, thereby ensuring that all eligible residents of Canada have "...reasonable access to insured health services on a prepaid basis, without direct charges at the point of service for such services". In other words, right across the country, Canadians are to have universal access to medical services and that these services are portable across provincial boundaries should residents move from one jurisdiction to another. Provincial health care plans are to cover all services offered by hospitals and physicians and that these services are to be offered without extra-billing or additional user charges. Should a jurisdiction allow extra billing, that amount will be deducted from the federal cash transfer. For example, from the passing of the CHA in April of 1984 to March 2010, a total of $9,159,619 has been deducted from federal cash contributions due to extra billing, an extremely small amount considering the size of transfers over the past 26 years. In 2011 - 2012, the Canada Health Transfer is projected to reach $27 billion, rising to over $30 billion in 2013 - 2014. Provinces also receive additional Canada Health Transfer support through tax transfers that amount to $13.6 billion in 2011 - 2012. In case you were interested, here is a history of Canada's health care funding.

Back to the PBO's note.

To put the following discussion into perspective, I'd like to take a brief look at the history of Canada's annual GDP growth rate since 1980:

You will notice right away that Canada's economy grew at an annual rate of 6 percent or greater for only very short periods of time over the last 32 years and averaged roughly 3 percent over the three decades. As shown here, over the past 10 years, Canada's annual GDP growth only reached 4 percent on 2 occasions and then only briefly:

From this data, we can quite clearly see that it is highly unlikely that, once 2017 - 2018 rolls around and the CHT transfers are linked to nominal GDP growth rate, the Feds will ever have to increase the transfers by more than 3 percent. Please keep these graphs in mind when reading the remainder of the PBO note.

As I noted above, once 2017 - 2018 rolls around, the size of the CHT transfers are linked to the rolling three year average of the growth level of Canada's economy. The PBO rather optimistically predicts that nominal GDP will grow by an average of 3.7 percent over the period from 2017 to 2024 which corresponds to a 3.9 percent three year rolling average. This is quite a bit higher than the historical norm as I noted above. This means that the PBO projects that the CHT transfers will grow on average by 3.9 percent annually from 2017 - 2018 to 2024 - 2025. This is significantly lower than the PBO's projected 5.1 percent growth rate in provincial health care spending over the same period. For the purposes of their simulation, the PBO also projects that the same CHT transfer growth rate will continue beyond 2024 - 2025 and that it will be maintained indefinitely at this level. Once again, this is significantly lower than the PBO's projected 5.3 percent growth rate in provincial health care spending over the same time period.

Now, let's look at two scenarios; first, the share of federal CHT funding as a percentage of total provincial health care funding under the current 6 percent escalator followed by the federal share of CHT funding as a percentage of total health care funding under the new, GDP-linked funding arrangement:

1.) Current 6 percent escalator: The federal CHT was projected to average 21.6 percent of provincial health care spending between 2011 - 2012 and 2035 - 2036, increasing to 26.8 percent over the next 25 years and increasing again to 38.1 percent of funding over the final 25 years as provincial spending on health care declined due to the "departure" of the beloved baby boomers.

2.) New GDP-linked escalator: The federal CHT is projected to decrease from its current level of 20.4 percent of provincial health care spending to an average of 18.6 percent between now and 2035 - 2036, decreasing further to 13.8 percent over the next 25 years and decreasing again to 11.9 percent over the final 25 years of the simulation.

Here is a graph showing how the two escalators impact the Federal share of provincial health care spending:

To put all of these numbers into context, over the period from 1968 - 1969 to 1976 - 1977, federal health transfers amount to an average of 36.1 percent of provincial health care spending as shown here:

These changes will have a marked impact on provincial treasuries since an increasing portion of the burden of providing health services will fall on their already overly-indebted shoulders. Provincial program spending (including health care), under the new scenario, is expected to increase from 17.3 percent of GDP to 23.9 percent of GDP by 2081 - 2082 as CHT transfers from the federal government decline.

Here is a graph showing how the consolidated provincial-territorial debt (in blue) and federal debt (in red) will rise as a percentage of GDP to 2081 - 2082 under the new CHT transfer scenario:

Notice that the federal net debt-to-GDP ratio actually declines over the six decade period but, in sharp contrast, the provincial debt-to-GDP ratio rises from 20 percent in 2010 - 2011 to 125 percent in 2050 - 2051 and to an astronomic 480 percent by 2081 - 2082. As a result of the changes to the CHT transfers, growth in provincial debt is projected to be higher than economic growth, an unsustainable situation. While I realize that projections 60 years out have a very low chance of occurring, it is important to have someone like Mr. Page look well beyond the four year election cycle horizon that our politicians are most comfortable with. It is just that short sightedness that has gotten us into this mess.

Basically, the federal government is transferring its debt to the provinces. As a taxpayer, the most offensive part of this scheme is that the level of federal taxation will not drop to meet the lower level of CHT transfers. This means that, as provinces cope with rising debt levels, Canadian taxpayers will most likely suffer as provincial tax rates rise in concert with increased debt. No matter which level of government experiences increased debt levels, it is the individual tax payer that will bear the load, that is, unless Canada's health care system suddenly becomes a great deal more efficient and is able to deliver more effective services for less money, a highly unlikely scenario. But, I guess as long as the Federal government's books look good, that's all that really matters...to them.

Greek Bonds - Double Your Money In No Time At All

2012-01-12T20:17:00.001-04:00

It seems that over the past few months, market sentiment around the world changes on a daily (or semi-daily) basis depending on what has happened (or perceived to have happened) in Europe. This is particularly noticeable in North America since our markets open well after both bond and stock markets have opened in Europe. I can't tell you how many mornings I've checked the online version of major North American newspapers to find one of the following banners:

"Market Futures Point Up on Easing of Fears About Eurozone Debt"

"Market Futures Point Down on Increased Worries About Eurozone Debt"

It was rather amusing this morning to note that the "teasers", as I call them, in one major Canadian newspaper had one from late yesterday proclaiming that Wednesday's market was down based on fears about potential debt downgrades in Europe while, the headline banner two “teasers” higher on the page, just after the market opened, stated that the market was up based on a good bond auction for both Italy and Spain. Did anything, other than sentiment, change?

As far as I can see, in recent weeks, absolutely nothing has changed regarding Europe's sovereign debt situation save one thing; we're now used to it. The Eurozone story has been moved from page one to page thirteen for the most part. It's unfortunate, but the mainstream media seems to ignore some facets of the ongoing story that are actually quite interesting and that may give us a heads up about what to expect in the future should other Eurozone nations face further fiscal pressures as surely they will, particularly since it appears that the better part of the world's economy is slipping into recession.

According to the Telegraph, the market was recently all aquiver because Italy and Spain sold three and four year bonds at far better rates than they had in recent months. Spain sold nearly €10 billion worth of bonds, twice what was expected at rates that were about 1 percentage point lower than previously and Italy sold €12 billion worth of one year bonds at 2.735 percent, less than half the rate from the previous month. This was cause for great rejoicing, despite the fact that Italy needs to repay €50 billion in debt in the first quarter alone and Spain has admitted that it will miss its 2011 deficit goal of 6 percent of GDP and hopes to reach a deficit of "only" 4.4 percent of GDP. Remember, even if Spain does achieve a deficit of 4.4 percent of GDP, that level is still well above the mandated European target of 3 percent. With the economies of both nations teetering on recession, the chances of actually meeting this target is negligible. As well, Europe’s bond market has been impacted by the European Central Bank having just dumped €489 billion into the coffers of Europe's banking industry, available to banks at only 1 percent interest. These funds are being used to promote purchasing of troubled European bond assets, so, perhaps banks are just playing the spread. Europe's banks are now able to purchase bonds from troubled Eurozone nations, pay the ECB 1 percent interest and pocket the difference. In the case of Italy's bond issue today, that works out to a fat 1.735 percent profit just for showing up and doing nothing, the only risk being that Italy could default.

Now, let's look at the story behind the story, focusing on poor old Greece which has been pretty much ignored these past weeks.

Here is a chart showing the yield on one year Greek bonds over the past three years:

Here is a chart showing the yield on two year Greek bonds over the past three years:

Here's one last chart showing the yield on two year Italy bonds for comparison, showing the recent interest rate drop :

Yes readers, you are not imagining things. While the mainstream media is all abuzz about the dropping yields on bonds issued by both Italy and Spain, they seem to have forgotten that the yield on a one year Greek bond is a stratospheric 403.34 percent and a whopping 170.1 percent for two years and, for the most part, still rising on a daily basis. The yield for the one year Greek bond at the beginning of November 2010 was a rather paltry 6.228 percent. Who in their right mind would have predicted that the yield would have climbed nearly 65 fold in just over 14 months? If you had told someone in November 2010 that the yield on Greek one year bonds would be in excess of 400 percent, they would have thought that you were daft. At this point in time, it would appear that the market has priced in complete default, with Greek bonds being worth little more than that white paper that comes on a roll.

What is most concerning is that a similar scenario involving the far more heavily indebted nation of Italy could prove catastrophic. According to the Banca D'Italia's most recent external debt statement, current to the end of September 2011, the country's external debt reached €1.848 trillion euros. Public debt in 2011 was expected to reach 119 percent of GDP, well below Greece's current level of roughly 160 percent of GDP and its projected level of 187 percent of GDP in 2013. That said, should part two of the Great Contraction entrench itself in the world's economy, even the best laid plans for fiscal finessing could go to waste and the world's third largest debtor nation could find itself battling interest rates approximating those being experienced by Greece now. That scenario would be the farthest thing from pretty.

The Woes Facing Europe - Federal Reserve Reverse Repurchase Agreements Revisted

2012-01-12T07:30:00.000-04:00

Back in September 2011, I took a look at the growing balance of reverse repurchase agreements (RRAs) on the books of the Federal Reserve. In light of the continuing debt issues facing the Eurozone, I wanted to very briefly update the situation, particularly in light of the fact that recent overnight deposits with the European Central Bank (ECB) have been reaching new record highs on a nearly daily basis, reflecting tensions in Europe's banking system.

First, let's revisit exactly what reverse repurchase agreements are and why their growing volume should concern you. In the inimitable words of the Federal Reserve, here is how they define reverse repurchase agreements:

"Reverse repurchase agreements are transactions in which securities are sold to a set of counterparties under an agreement to buy them back from the same party on a specified date at the same price plus interest. Reverse repurchase agreements may be conducted with foreign official and international accounts as a service to the holders of these accounts. All other reverse repurchase agreements, including transactions with primary dealers and a set of eligible money market funds, are open market operations intended to manage the supply of reserve balances; reverse repurchase agreements absorb reserve balances from the banking system for the length of the agreement. As with repurchase agreements, the naming convention used here reflects the transaction from the counterparties' perspective; the Federal Reserve receives cash in a reverse repurchase agreement and provides collateral to the counterparties."

Bankerspeak, right?

Here's my explanation from back in September:

"Reverse repurchase agreements are nothing more than the purchase of a security by a party with the agreement that the purchasing party will be able to sell them on a specific date in the future at a higher price. For the party selling the security and agreeing to repurchase it in the future, the action is known as a "repo". For the party who buys the security and agrees to sell it in the future, the action is known as a reverse repurchase agreement. According to Investopedia, these transactions are classified as money-market instruments.

In the specific case of the Federal Reserve, the central bank uses reverse repurchase agreements to temporarily add or subtract reserve balances in the open market (the amount of money in the system) and to temporarily offset swings in bank reserve levels. In 2009, the Federal Reserve used reverse repurchase agreements to drain some of the $1 trillion that they pumped into the economy during the Great Recession. By selling securities to the 18 primary dealers in the Fed's universe, they can decrease the amount of money available in the banking system. The removal of "money" can result in both an economic slowdown and inflationary pressures, one of the great concerns of removing "paper" that has been created out of thin air from the system.

That's enough background information.

Let's take a look at what has happened to RRAs, most particularly those that the Fed is holding for foreign governments, central banks and other international organizations including the IMF and the BIS (termed Reverse Repurchase Agreements - Foreign Official and International Accounts or WWRRAFOIAL), since 2003:

What alarmed me back in September was the very rapid growth in RRAs over the summer months in 2011, a situation that was parallel to what was experienced back in 2008, during the initial phase of the Great Recession, as you can see on the graph. While it looked like the volume of RRAs was dropping in the early fall, the increase in the volume of dollars invested by foreign governments and organizations has continued nearly uninterruped and is now well above the spike in 2008 and just below peak levels reached in mid-2011 excluding the spike in late 2011. You will also notice that the size of RRAs held by the Fed never declined meaningfully after the "end" of the Great Recession and that there has been another substantial step upwards. This is telling us that Europe's central banks, governments and organizations including the IMF and BIS still don't trust the security of their own banking system and that they haven’t for the past three years.

Taken in combination with record levels of deposits with the European Central Bank, the situation is starting to look very bad as shown on this graph:

European banks have deposited nearly €486 billion with the ECB at very, very low interest of only 0.25 percent since they don't trust each other, nor do they wish to loan the money to consumers or corporations. What is really odd is that the ECB just loaned 523 European banks €489 billion for three years at 1 percent to keep money flowing in the Eurozone through increased lending. This lack of liquidity is concerning since it will make it difficult for the economy to expand and keep the Eurozone out of recession.

As we can see, while the European situation has faded from the front pages of the business sections of most mainstream media outlets, the woes facing Europe are hardly behind us. As European banks trust each other less and less resulting in a tightening of the credit screws, the situation is starting to look more and more like the United States in 2008 – 2009 when bank lending froze. Unfortunately, we all know how that story ended. With the world's economy so interlinked, perhaps this time out, both Canada and the United States will be the nations suffering from collateral damage from the European banking system instead of the other way around.

Negative Sovereign Bond Yields - A Sign of Fiscal Stress

2012-01-11T07:30:00.000-04:00

A financial news story from earlier this week received very little media attention, particularly considering its importance in the scheme of the unwinding of both the Euro and the European Community and the world’s overall sovereign debt crisis.

On January 9th, the Bundesbank, Germany's central bank, auctioned 6 month German Treasury discount paper maturing on July 11th, 2012. A total of €3900 million was auctioned with bids received for €7080 million. Here is a summary press release from the Bundesbank showing the results of the auction:

Notice that the lowest accepted price was 100 percent and the weighted average price was 100.00616 percent with average yield over the entire auction of negative 0.0122 percent. Yes, you read that correctly, the yield on a 6 month German Treasury was negative! In case you are confused, remember that Treasuries (including those of the United States, Canada, the United Kingdom et al) are purchased at a discount and redeemed at full value. For example, a one year Treasury yielding 3 percent will be purchased at a 3 percent discount from its maturity value and then redeemed for 100 percent of its value upon maturity. In this week's case, purchasers of German Treasuries actually paid an average of €100.00616 for every €100 worth of Treasuries that they will only be able to redeem for €100 on July 11th, 2012.

This is the first time in history that a Bundesbank auction of short-term German government bonds have resulted in a negative yield. This means that buyers of the German Treasuries are actually paying the Bundesbank for the privilege of owning their paper.

This is not the first time that German bonds have traded with a negative bond yields, however, in the other cases, the yields became negative on the open bond market as shown here:

Notice that all of the short-term bonds maturing in 2012 at the top of the list have negative market yields.

This is not the first time that European government issuers have auctioned bonds with negative yields. Switzerland, Denmark and the Netherlands have all recently sold bonds at negative yields. This shows us just how desperate the world's sovereign debt situation has become. Major bond investors are either avoiding the bonds of debt-encumbered Eurozone nations or demanding punishingly high yields as shown here in the case of Italy's 6 month bonds:

Why would anyone purchase a bond with a negative yield? First, risk avoidance has become the name of the game. Investors are looking to hide their cash wherever they perceive safety, unfortunately, safety is just an illusion. Second, Europe's private sector banks can purchase government bonds and use them as collateral against funds that they wish to borrow from the European Central Bank. These funds which are borrowed from the ECB, most recently at 1 percent, are then loaned to consumers. Unfortunately, the credit market in the Eurozone is very tight, with credit standards rising as shown in this article. This is part of the problem facing the Eurozone; banks no longer trust each other, consumers and corporations and are depositing their overnight funds with the ECB rather than with other banks.

Seeing negative yields on rising levels of sovereign debt is a relatively new phenomenon. Remember, that while Germany is the most prudent of the Eurozone nations, it still sitting on €1.116 trillion of debt. Bond investors are now choosing among the best of a bad lot but that doesn't necessarily guarantee that their decisions will pay out over the long term. The fact that any investor would pay any government to hold on to their cash for them is a very telling sign that the system is broken.

America's Political Action Committees - Follow the Bouncing Buck

2012-01-09T20:13:00.000-04:00

In yesterday's posting, I noted how difficult it was to track donated money within the political system of the United States. Despite the efforts of the Federal Election Commission (FEC), the very existence of thousands of Political Action Committees (or PACs) makes it nearly impossible to follow a dollar within the system. In this posting, I’d like to illuminate the issue in more detail. For source material, I am using the OpenSecrets.org website and the Federal Election Commission website.

Let's open by explaining PACs to those of my readers that are not American. PACs are private groups that are organized to elect political candidates of any given political persuasion. Here is a screen capture from the Federal Election Campaign Act outlining what a PAC is:

Basically, when a corporation or organization wishes to donate to a political party or candidate, they must do so through a PAC since the aforementioned are not allowed to directly contribute since it would be seen to be a conflict of interest or a form of bribery (not that PACs aren't, it's just legal that way!). In the case of corporate PACs, various corporations will raise money from their employees or shareholders in an attempt to ultimately further their particular cause once the party or candidate they have chosen to back financially is elected. In the case of organizational PACs, individuals that support a particular social cause may choose to donate to a like-minded PAC that will promote their beliefs.

From United States Census Bureau data, here is a screen capture showing the growth in the number of PACs since 1980:

PACs account for less than 30 percent of all contributions in United States Congressional elections and less in Presidential elections, nonetheless, they are an extremely important fundraising mechanism. Here is a screen capture from the Census Bureau showing how much was raised by all PACs in the years from 2003 to 2008 by type of PAC:

That's a whopping $1.212 billion raised in 2007 - 2008 alone. That’s a lot of lawn signs, television and newspaper advertising!

Here is a screen capture from Open Secrets showing just how much money the top 20 PACs contributed to candidates in the 2007 - 2008 election cycle:

It is interesting to see that there is a very, very wide range of interest groups in the top 20, mostly industrial or financial in nature, that wish to "bend the ear" of those dwelling in the ivory towers of Washington. Who says money can't buy influence?

Here are the top 20 PACs thus far in the 2011 - 2012 election cycle, remembering that we are still very early in the cycle:

As noted in the screen capture at the beginning of this posting, under Federal law, PACs are allowed to contribute up to $5000 to a candidate committee once per election, up to $15,000 annually to a national party committee and $5000 annually to another PAC. However, there is no limit to how much PACs can spend on advertising in support of their candidate or in opposition to those running against their chosen candidate.

Now, let's get to the purpose of this posting. According to Open Secrets, the sixth largest PAC during the 2010 election cycle was the American Bankers Association (ABA). The ABA represents banks of all sizes and is "...the voice for the nation's $13 trillion banking industry and its 2 million employees". Here is a historical look at what the ABA has raised and donated since 1990 focusing on how much they raised and spent in 2010:

The ABA doled out 32 percent of their support to the Democrats and 67 percent to the Republicans in 2010.

Now, let's flip to the information available on the FEC website. Here's a summary of the ABA’s funding for the most recent election cycle:

If we click on the "Contributions to Other Committees" link, it takes us to a listing of all the Committees that the American Bankers Association contributed to. It is a rather massive list, isn't it? I picked out one of the Committees, the rather interesting sounding "Blue Dog Political Action Committee" and dug a bit deeper. Blue Dog received $5000 from the ABA in 2011. Here's what Blue Dog has been up to during the most recent cycle according to Open Secrets:

Notice that 100 percent of their support in their last report of 2011 went to Democrats. Back in 2010, 99 percent of their donations went to the Democrats. That's quite a different story than one would think from the contributions that were made by the American Bankers Association who gave only 32 percent to the Democrats in 2010, isn't it?

Now, let's continue to follow the bouncing buck by looking through the list of the Committees that Blue Dog PAC donated to. Right at the very top, we find the "3rd and Long PAC". This small, North Carolina-based PAC received $5000 from the Blue Dog PAC in 2011. Here is the summary report from the FEC for the 3rd and Long PAC:

Now, let's see where 3rd and Long spent its money this year:

Ms. Giffords (D - Arizona) and Mr. Heinrich (D - New Mexico) both received $1000 from 3rd and Long in 2011. That’s 100 percent to the Democrats in 2011 and only three degrees of separation from the original American Bankers Association PAC.

Now you can see just how difficult it is to follow any donated dollar through the system. With PACs so strongly interlinked, it is nearly impossible for Main Street Americans to learn who they are ultimately supporting, should they choose to donate to a PAC. As well, while PACs can be useful in bringing together like-minded individuals that wish to promote their particular cause, why should it be necessary for voters to donate to any party or candidate to have their voice heard (he said naively)? After all, every vote should be equal, unfortunately, as we all know, that is far from the case. It is the moneyed voices who speak the loudest in American politics. Perhaps it's just easier for us to think of PACs as a legal form of bribery.

American Politics - Who's Funding the Candidates and How Easily Can Funds Be Tracked?

2012-01-09T07:30:00.001-04:00

I spent a bit of time today looking through the Federal Election Commission (FEC) website at the funding for the remaining Republican Presidential candidates. I did find some interesting contributors as I will outline in this posting and I will concentrate on only four out of the hundreds that have made running for political office a "race for the bucks". There are two purposes for this particular posting; first, to show my readers a sampling of who is behind the political party of their choice and how vast their financial power is and second, to show readers how difficult it can be to police the current political contribution limits as prescribed in Federal election laws.

I would like to open with a quick look at political contribution limits for 2011 - 2012 from the FEC website explaining the limits of contributions to candidates and political committees:

With that as background information, let’s move to the first of our four political contributors or Political Action Committees (PAC). The first one that stuck out was POET PAC. At first glance, one would think that perhaps a group of rhyming writers got together and formed a political action committee. Alas, that is not the case. POET happens to be the world's largest ethanol producer, producing more than 1.6 billion gallons of ethanol annually from their network of 27 plants in seven states. They claim the following:

"The people of POET are currently replacing millions of barrels of imported oil every year with clean, renewable energy. All while pumping billions of dollars back into the American economy."

I think that they forgot to mention the 45 cent per gallon or $6 billion per year subsidy that Washington (i.e. you the taxpayer) gives to ethanol refiners. According to the Environmental Working Group, between 2005 and 2009, American taxpayers spent $17 billion subsidizing domestic ethanol production; for all of this effort, America's overall oil consumption dropped by the equivalent of a very, very meagre 1.1 mile per gallon increase in fuel economy. The authors of this study claim that, rather than spending $17 billion to subsidize the ethanol industry, these fuel savings could have been achieved for free.

Back to POET PAC. Here is a screen capture from their website:

That's right. POET is not allowed to directly contribute to federal political candidates so they formed POET PAC to do it for them. Once again, as we all know, Corporate America is a whole lot smarter than Washington and there's always a way around any given law. While they claim to be bipartisan, in the 2012 cycle, 76 percent of their donations went to Republicans.

Here is a screen capture showing which issues are important to POET PAC:

Apparently, POET PAC will support any candidate of any Party that is seen to "support candidates...who stand up for issues that are important to our future.". I'm not certain whether they mean issues that are important to America’s overall future or more specifically to POET’s future but I think that I can guess.

Here's what POET has been up to during the 2011 - 2012 cycle:

Most of their contributors during 2011 were farmers (one would assume corn farmers in particular since it is the feedstock for ethanol) and various POET executives including the company's President, COO, General Counsel, VP of Communication and VP of Corporate Finance.

Now, after that detour, let's go back to the GOP Presidential candidate finances and how much POET has contributed to each candidate:

Mitt Romney: $5000

Newt Gingrich: $5000

Tim Pawlenty (withdrew): $5000

Now, on to the next interesting donor/committee.

Rick Santorum who, until recently, was trailing the pack at fundraising, has only a handful of Committees that have made contributions to his efforts as shown here:

In Mr. Santorum's case, the committee that stuck out was the rather innocuous sounding Citizen's United Political Victory Fund (CUPVF). I wonder who thinks of these names? The mission of CUPVF is to support conservative candidates running for federal office who share their vision of reducing the size and scope of government, lowering taxes, cutting spending, promoting traditional family values and winning the war on terror. Motherhood statements, right?

CUPVF is the fundraising side of Citizens United, an organization dedicated to “…restoring our government to citizen's control”. The President of Citizens United, David N. Bossie, was chief investigator for the U.S. House of Representatives Committee on Government Reform and Oversight and spent at least part of his time in Washington in the 1990s investigating President Bill Clinton's involvement in Whitewater and foreign fundraising during the 1996 Clinton re-election campaign. More interestingly, his organization has produced various documentaries, one of which was hosted by Newt and Callista Gingrich. Citizens United has also just released a pro-life documentary video entitled The Gift of Life, hosted by none other than Mike Huckabee, yours for a "donation" of only $19.95 plus shipping and handling.

Now, let's see what CUPVF has been up to during the 2011 -2012 cycle:

They seem to be quite efficient at fundraising for a non-corporate entity, don't they? According to Open Secrets (and not surprisingly), 100 percent of their contributions went to Republican candidates in 2012 and 2008 when they raised a whopping $3.732 million and donated $3.067 million. That's not chump change!

Now, let's see which GOP Presidential candidates benefited from their largesse:

Michele Bachmann (withdrew): $5000

Newt Gingrich: $5000 (no surprise there!)

Rick Perry: $5000

Rick Santorum: $5000

Now, let's move along to the third donor/committee that I found interesting, particularly since I come from the energy sector. Valero Energy Corporation Political Action Committee or VALPAC is affiliated with Valero Energy Corporation, a Fortune 50, San Antonio, Texas-based refiner and marketer of petroleum products. It owns 16 refineries and 10 ethanol plants throughout North America, the United Kingdom and the Caribbean, making it the world's largest independent petroleum refiner and marketer. Valero believes that:

"…it is in the best interest of Valero’s stockholders that federal, state, and local governments understand how their actions impact Valero’s business and stakeholders. Accordingly, Valero communicates with governmental organizations and officials about its business concerns."

Since law forbids Valero from using corporate funds to make contributions to political parties and candidates, it raises money voluntarily from employees and shareholders through VALPAC. According to the Open Secrets, VALPAC has historically been a rather large PAC as shown here:

In the 2012 cycle, VALPAC had total receipts of $877,000 and disbursed $821,000 thus far, 92 percent of which went to Republicans as shown here:

In its best year back in 2008, VALPAC raised a massive $2.476 million and disbursed just over $2.5 million, 83 percent of which went to Republicans.

Now, let's see which Republican candidates benefitted from VALPAC:

Rick Perry: $5000

That's the only GOP Presidential candidate that VALPAC has deemed worthy of their support in 2012. Perhaps VALPAC was just a wee bit more comfortable with a boy from Texas. In the immortal words of Rick Perry and, on behalf of VALPAC, I'd say "Oops"; at this point in time, it wouldn’t appear as though that particular donation was worth it. Now, it will be interesting to see which GOP candidate VALPAC throws its ample weight behind when Mr. Perry decides that enough is enough and withdraws from the race.

Let's look at one last donor from the past. E*Trade is best known for it's cheaper than cheap online stock trading commissions. Apparently, they were also known for their political activism through donations to many of the "name brand" politicians in the United States. For instance, Barbara Boxer received $8500 between 2000 and 2004, Eric Cantor received $10,000 between 2001 and 2004, Hillary Clinton received $10,000 in 2004 and Barak Obama received $5000 from E*Trade Financial Corporation PAC. Back in May 2007, Mitt Romney, also received a small contribution of $5000 toward his Presidential candidacy. According to Open Secrets, E*Trade Financial is no longer active, having spent a massive $10 during the past year, however, they have raised up to $330,000 and spent up to $220,000 during the 2006 cycle as shown here:

I was rather surprised to see a company best known for its discount brokerage arm in among the “business big boys” but perhaps it’s a case of keeping up with the Joneses. One never knows when one might need the lend of an ear in Washington.

I hope that you learned a bit about four of the fundraisers with differing agendas that back America's politicians with rather large sums of money. Now I’d like to take a very brief look at how difficult it can be to track political contributions as they work their way through the system.

As I've said before, the Federal Election Commission website is a veritable fount of information. It certainly does provide everyday Americans with a sense of who the power brokers are that are supporting their favoured political candidates and parties with huge amounts of money. That said, there is one problem with this so-called "transparency", unless you are willing to connect all of the dots between one PAC and all the PACs that they donate to (in the case of large PACs like VALPAC, there are dozens), it is very, very difficult to follow the trail of money. For example, while VALPAC did not support Michele Bachman's 2012 run for the Presidency, she did receive $7000 back in 2006 and 2007 from VALPAC. On a more interesting and less apparent note, she received another $13,896 in 2006 and 2008 from the Rely on Your Beliefs Fund which received $32,500 from VALPAC between 2003 and 2010. Here's another example of the obtuse relationships between committees; between 1999 and 2005, Rick Santorum received $12,000 from Fund for a Conservative Future which received $50,000 between 2002 and 2011 from VALPAC even though Mr. Santorum received nothing from VALPAC directly. It is those nested donations from one committee to another that makes following the money trail from donor to ultimate recipient very, very difficult for Main Street Americans who wish to know who is backing their particular brand of politics. It's almost like a money laundering scheme; if a given donation moves between enough PACs, its origins are hard to trace. While I understand the need for contribution limits as I noted at the opening of this posting, the current system makes it nearly impossible to really determine if Federal Campaign Finance Laws are being followed. It would certainly appear that, at the very least, the intent of the law is being flouted.

American Unemployment - Who Has Suffered The Most?

2012-01-05T07:30:00.000-04:00

While the headline jobless claims and overall unemployment statistics are showing modest improvement in America's overall employment picture, it is interesting to look behind the sterility of the numbers and examine just who is suffering the most and who is benefiting the most during this jobless "recovery".

In their paper entitled "Employment Patterns During the Recovery: Who Are Getting the Jobs and Why?", Ausegul Sahin and Jonathan Willis of the Federal Reserve Banks of New York and Kansas City respectively, examine the distribution of employment losses and gains during the most recent recession measured by educational level, gender and age. An analysis of this data shows a fairly clear relationship between the amount of education an individual has, their gender and their age and their chances of losing and regaining employment in this very difficult market. Please note that the data in this study is current to the end of August 2011.

During the Great Contraction from December 2007 to January 2010, the American economy lost 7.8 million jobs; on the flip side, employment of workers aged 16 and older increased by a very paltry 1.1 million over the 19 month period from January 2010 to August 2011. This employment gain data can be broken down further by gender, age and by level of educational attainment as shown in this table:

Looking at educational level, we can see immediately that the vast majority of the job gains were experienced by older males with at least some college education; those with a degree experienced an increase in employment of 1.1 million and those with a least some college experienced an employment gain of 345,000. On the other hand, those with high school or less experienced total employment contraction of 642,000. Note that there is also a very strong gender bias in the job gains; men gained 1,514,000 jobs while women saw a net drop of 314,000. Worker age also played a very strong role in employment gains with just about all of the gains experienced by workers aged 55 and over; this group saw employment gains of 1,430,000 with workers aged 25 to 54, who make up the vast bulk of America's workforce, seeing a drop of 512,000 jobs.

Let's examine each of the three factors, educational level, gender and age to see how they affect employment gains and losses.

Educational Attainment:

The level of educational attainment has a strong impact on the level of job growth since the "end" of the last recession. Looking back a decade, it is becoming apparent that employment gains in the recovery phase of an economic cycle are showing a trend toward a more educated workforce. This really shouldn't be all that surprising considering the "gutting" of America's manufacturing sector over the past three decades. Here is an interesting graph showing that America's manufacturing sector has seen its share of the jobs market drop from 30 percent in 1950 to around 10 percent in 2007 as jobs moved overseas:

As I noted above, employment gains during the 19 months starting in January 2011 were concentrated among workers with at least some college education. Here is a graph showing the average monthly growth in employment from January 2010 to August 2011 for all four groups in black, the peak to trough job losses from December 2007 to January 2010 in grey and the peak to peak job gains from March 2001 to December 2007 in blue:

Peak to trough employment (grey bars) fell the most for high school graduates with no college. These workers saw a drop in employment of 110,000 jobs per month over the period from December 2007 to January 2010 while those with a Bachelor's degree or higher saw modest monthly employment gains of 10,000 jobs. Even as the economy turned north (black bars) between January 2010 and August 2011, high school graduates with no college still saw the number of jobs shrink by 30,000 per month in contrast to those with a Bachelor's degree or higher who saw employment gains of 58,000 per month.

Over the peak to peak period from March 2001 to December 2007 (blue bars), by far the greatest employment gains were experienced by Americans with a Bachelor's degree or higher. These Americans saw average monthly employment gains of 89,000. For workers with some college, the growth with still at a reasonable 28,000 per month and was practically non-existent for those with high school or less.

Here is an interesting graph showing how employment changed for lower education industries including manufacturing, construction and transportation:

Note how these sectors were hit very hard during the latest recession with job losses (grey bars) ranging from just over 20,000 per month to 90,000 per month and how job recovery (black bars) has been modest at best with job additions ranging from 15,000 to 21,000 per month, a rate that is far, far below the jobs lost.

To summarize these observations, American workers that have attained at least some college are the only group that has seen employment growth over most of the past decade. On the other hand, American workers with a high school diploma or less have seen the weakest job growth and have suffered from the highest level of employment contraction as the Great Recession took hold and during the aftermath.

Employment Patterns by Gender:

During the recent economic bust and boom, males have experienced the greatest fluctuation in employment. The decline in employment for men accounted for 70 percent of total job losses during the contraction phase and the gain in employment for men accounted for 90 percent of the total job gains during the recovery phase.

Statistics show that employment opportunities for men have grown by an average of 88,000 per month (black bars) since January 2010 in contrast to women who have seen their job opportunities increase by only 9,000 per month as shown on this graph:

During the down side of the cycle, between December 2007 and January 2010, men saw their employment prospects decline by 242,000 per month (grey bars) in contrast to women that saw their prospects decline by "only" 106,000 per month.

The sharp decline in male employment was likely related to the sectors of the economy that experienced the greatest contraction during the latest recession (i.e. construction, manufacturing and trades, transportation and utilities) since these sectors of the economy hire more males than females. Since the construction and manufacturing sectors have hardly recovered since the Great Recession, how is it that men have experienced the greatest employment gains? For two reasons; first, because men made up a larger fraction of the overall jobless pool (56 percent of the total unemployed) and second, because men's behaviour is different than that of women since men tend to be more attached to the workforce than women. The authors suggest that men are more likely to accept jobs that pay poorly when faced with the alternative of unemployment in very tight job markets. As well, women are generally more likely to stop working when their wages decline since men are less sensitive to declines in wages. In addition, men with lower levels of education may be willing to accept lower paying jobs since the jobs market in America has swung in favour of more highly educated workers. Employers may well be looking at the increased pool of rather desperate unemployed workers and making a decision to hire more highly educated workers than they normally would since the labour of these out-of-work males may be available at bargain basement prices.

Employment Patterns by Age:

I was quite surprised to note that employment growth since the so-called end of the Great Recession has been mainly among those aged 55 and older. To me, that seems almost counter-intuitive. Employment gains for Americans 55 years of age and older has increased by 75,000 per month (black bars) since January 2010, in contrast, employment levels for Americans between the ages of 25 and 54 have actually declined by an average of 27,000 per month over the same period of time. This is somewhat surprising since the younger age group is considered to be the prime age for employment. Here is a graph showing job gains and losses for each of the three age groups:

Employment of prime-age workers showed the sharpest decline during the down side of the cycle between December 2007 and January 2010 with job losses averaging 255,000 per month (grey bars) compared to job gains of 48,000 per month for workers 55 years old and older. How can this be explained? Over the past decade, demographic changes have come into play as baby boomers age. The overall share of prime-age workers (54 and under) has dropped from 57 percent to 52 percent and the share of older workers has increased from 27 percent to 32 percent. This demographic shift alone accounts for 88 percent of the total monthly employment increase for older workers. In contrast, the shrinking number of prime-age workers accounts for only about half of the total decline in employment for that age group. Even during the recovery, the prime-age group has lost an average of 16,000 jobs per month when comparing the size of their cohort to the overall population (i.e. correcting for the shrinking size of their cohort). This indicates that the recession's impact on employment was (and still is) very severe.

Another factor that enters the employment pattern by age is the shift in retirement age. Declines in the value of real estate and other investments are resulting in more Americans working later in life. There are increased numbers of Americans working well into their 70s; as time passes and the demographic patterns shift toward an older and older population, it is expected that Americans over the age of 55 will make up an increasing proportion of the workforce.

In conclusion, in spite of recent improvements in jobless claims and unemployment statistics, this study shows that the recovery has not treated all members of American society equally. Employment growth has been concentrated in jobs where more highly educated workers are required. As well, men are more likely to take jobs that they may not feel are suitable (i.e. don’t pay as well) over the longer term because they are often more attached to the workforce than women; this has improved the job situation for the hairier gender at the expense of women. Older workers have also been net beneficiaries of the "recovery" as the work force shifts toward older workers. From this data, it is apparent that the current sluggish recovery in America's job market is not related to a mismatch between workers and jobs. Rather, the demand for the most sought-after workers has simply not kept pace with growth in the size of the overall population. In closing, these two graphs showing the declining labor force participation rate since the 1940s for both men and the more recent decline for women pretty much explains why the American employment issue is stubbornly intransigent and on trend with past economic behaviour:

The Republican Primary Candidates - They Definitely Aren't One of "Us"

2012-01-02T19:30:00.000-04:00

I don't know if you have ever taken the time to visit the website Open Secrets, but it is a fascinating treasure trove of all things government, most particularly, money in government. This Washington-based non-partisan, independent and nonprofit research group tracks money within the United States political game and how it impacts elections and public policy. Here is their three part mission quoted verbatim from their website:

• Inform citizens about how money in politics affects their lives

• Empower voters and activists by providing unbiased information

• Advocate for a transparent and responsive government

In light of 2011's OWS movement and the impending 2012 Presidential election and primary cycle, some of the data that can be mined from this website is most compelling. What I'd like to do for this posting is to select some interesting facts regarding the personal assets owned of the major Republican candidates. By doing this, I hope that my readers will see clear evidence for something that most American's know in their "gut", that federal politics has become a playground for the tiniest fraction of the "one percent".

Fortunately for Americans, every Presidential election cycle, Presidential candidates have to file Personal Financial Disclosures that outline their net worth (within predetermined brackets) and their sources of income. For this posting, I will take a more detailed look at the finances of several of the Republican Presidential candidates, I will include screen captures showing salient points about their investing strategies and their overall net worth, particularly as it relates to their status in American society.

First up and the top of the heap, Mitt Romney. On this page, you'll note that Mr. Romney owns between $250,001 and $500,000 worth of gold, a fact that I find most interesting:

As well, you'll see that he is very well compensated for his services as both a director and a public speaker. He was paid a Director's Fee of $113,880.73 for his services to Marriott International and was paid between $11,475 and $68,000 for each of nine speaking engagements during the year from February 2010 to February 2011 for a total of $374,327 just for talking! That's roughly seven times the average household income in the United States. While I realize that the going rate for public speeches by the elite is very high, I just don't see that any speech is worth $68,000 but then, that could just be me.

Here's another page from his Disclosure showing some of Mr. Romney's other assets:

Notice that he owns twelve Federal Home Loan Bank (FHLB) debt instruments ranging in size between $1,000,000 and $5,000,000 in size and another five ranging in size between $500,000 and $1,000,00 for a total value of between $15,500,000 and $65,000,000. Mere pocket change! These government issued agency bonds are triple-A rated and are used to increase the availability of funds for mortgages. Later in his disclosure, he also lists an additional four FHLB debt instruments with a total value of between $4 million and $20 million. It must be a full-time job keeping track of all of this money...except that it's held in a blind trust and somebody else gets paid to do the heavy lifting for Mr. Romney.

Enough of that. On to Ron Paul. Mr. Paul has a very interesting portfolio as shown on these two pages:

Mr. Paul is heavily invested in both gold and metals mining companies including Barrick Gold ($100,001 to $250,000), Eldorado Gold ($50,001 to $100,000), Goldcorp ($500,001 to $1,000,000), Iamgold ($250,001 to $500,000) and Newmont Mining ($250,001 to $500,000). From what I can see on his Disclosure, he has a very, very interesting and non-mainstream outlook on the world and it's really not that difficult to see where he thinks that the world's economy is headed. At least, in Mr. Paul's case, his investing strategy reflects both his actions and his words. He also has between $250,001 and $500,000 on deposit with the First National Bank of Lake Jackson in Texas. From the same bank, he has a personal loan for between $250,001 and $500,000 for 5 years at 3.75 percent.

Now, on to Newt Gingrich. Here is a screen capture showing some of his assets:

His largest investment is in his Alliance Bernstein 2010 Retirement Strategy Class R where he has between $500,001 and $1,000,000 followed by his stake in Gingrich Productions, a multimedia production company owned by Mr. Gingrich and his wife Callista, also valued at between $500,001 and $1,000,000. In 2010, Gingrich Productions paid Mr. Gingrich a cool $2,453,409 in "distributive shares" as shown here:

Mr. Gingrich also has CDs at several banks including Columbus Bank, Medallion Bank and GE Money Bank where he has five CDs ranging in size between $50,0001 and $250,000. He has money scattered in several dozen funds in very small amounts, generally less than $15,000 each. Like most Americans, he does have more than one checking and savings accounts; unlike most of America, the balance in his WellsFargo account alone is between $250,001 and $500,000. In fact, in his three checking and savings accounts, he had a total balance ranging between $400,000 and $850,000, pretty much what I have in my checking account today. What I found most interesting on the liabilities (debt) side of the ledger was his now paid-off revolving account with Tiffany & Co. for between $500,001 and $1,000,000 as shown here:

Yes siree, Mr. Gingrich is just like the rest of America, isn't he? I suspect that the vast majority of Americans have a revolving credit account at Tiffany & Co, don't they?

Next up to bat, John Huntsman. Mr. Huntsman's main asset is his ownership in Huntsman Family Holdings Company (basically, holding stock in Huntsman Corporation), which sprang forth from his tenure as CEO at his father's Huntsman Corporation, a global chemical company, valued at between $5,000,000 and $25,000,000 which paid him between $100,000 and $1,000,000 in dividends last year as shown here:

Like the other candidates, Mr. Huntsman has a rather large balance in his checking and savings account, ranging between $250,000 and $500,000. As well, Mr. Huntsman has also set aside a substantial amount of money in trust for five of his seven children; each child has between $15,000 and $50,000 in checking and savings accounts at Zion's First National Bank in Salt Lake City, between $250,000 and $500,000 in Jordan Utah School District Government Bonds, between $15,000 and $50,000 in Payson City Utah Sewer Bonds and an additional $15,000 to $50,000 in Blackrock Provident Institutional Funds for a total of between $1.475 million and $3.250 million. Mr. Huntsman also owns a residential rental property in Cordonado, California worth between $1,000,000 and $5,000,000 as shown here:

Let's close this posting with a quick look at Rick Santorum's finances. As shown on this screen capture, Mr. Santorum is BIG into rental properties:

All told, his five rental properties in Pennsylvania have a declared value ranging between $500,000 and $1,250,000 with rental income ranging from $15,001 to $50,000 each on an annual basis. He has the obligatory checking accounts, the largest of the three has a balance of between $50,001 and $100,000. All I can say is, these candidates really like to carry large balances in their checking accounts! He has a sampling of stocks that lean toward the pharmaceutical and tech side with valuations generally between $1001 and $15,000 each, most held in various funds or as individual stocks in his IRA with Stifel Financial. He also has a small E*Trade account that holds 10 stocks with a value ranging from $10,000 to $150,000. His other compensation is rather eye opening; as a columnist, contributor or consultant for companies ranging from the Philadelphia Inquirer to Consol Energy to his position as Senior Fellow with the Ethics and Public Policy Center, he raked in $896,037 in 2010. That's quite a pay packet, roughly 18 times what an average American family earns in a given year!

Now for the bad news. Here are Mr. Santorum's liabilities:

He owes between $350,000 and $750,000 on his rental properties in Pennsylvania, meaning that his actual equity in his rental properties ranges from $150,000 to $500,000.

I think that the information provided in this posting is enough to make my point. While the GOP candidates may come across as sympathetic to the plight of ordinary unemployed, underemployed and foreclosed upon Americans, the Financial Disclosure data released by Open Secrets tells another tale; these five individuals definitely live way, way on the other side of the tracks. In fact, they can hardly really see "our" side of the tracks from their vantage point.

Presidential Elections in America - Brought to You by the "One Percent"

2012-01-01T00:00:00.000-04:00

In light of the impending Republican primary season and, in conjunction with the recent Occupy Wall Street movement and its emphasis on the growing dichotomy in American society, I thought that it would be interesting to take a look at Presidential election campaign financial statistics from the 2008 Federal election as well as the more recent Republican primary race for the Presidential candidacy. I'll start with the statistics from the 2008 election and follow up with the more recent GOP race for the nod. Please note that most of my financial statistics have been gleaned from the Federal Election Commission (FEC) website. Before you start reading, I realize that the fundraising efforts for the Republican primary are far from over, nonetheless, I think that the data released to date gives us an interesting snapshot regarding financial support levels for each of candidates.

Let's open by looking at how many votes were cast three years ago. In the 2008 election, there were a total of 131,257,328 votes cast; 59,934,814 (or 45.66 percent of the popular vote) for the Republicans who had selected John McCain as their candidate and 69,456,897 (or 52.92 percent of the popular vote) for Barak Obama. Ralph Nader followed in distant third place with 738,475 votes (or 0.56 percent of the popular vote). Let's put these numbers into perspective. The Census Bureau reports that in 2008, there were 206.072 million American citizens aged 18 years and older. Of these, 146.311 million were registered to vote in 2008 representing 71 percent of all potential voting-age Americans. This is a decrease in registration of 1 percentage point from the 2004 election; of these registered voters, 89.6 percent actually voted in 2008. When the ballots were all counted, 63.6 percent of all voting-age citizens took the time to cast a ballot, roughly the same percentage as in 2004 as shown on this chart:

Now, let's look at the total fundraising for the 2008 Presidential campaign to the end of December 2008 noting that a massive $1.334 billion dollars was raised from individual Americans. Here is a summary of the total contributions as well as the average size of the donations made by individuals and how much was raised for a given donation size range:

Notice that, while 32 percent of the donations made by individuals were under $200, just over 31 percent of all Presidential Campaign donations were $2000 and larger. In case you weren't aware, under the United States Federal Campaign Finance Law, the limit that individuals may contribute to a candidate or candidate committee per election is now $2500 (it was $2300 in 2008) but that, should you happen to have $30,800 lying around doing nothing, you would still be within the law if you donated that amount to a national party committee once every calendar year! Here is a chart from the FEC website showing how the contribution limits vary according to the ultimate destination:

Americans that contribute more than $2000 to their favourite federal political cause would most likely be considered among the higher income class in the United States since most of Main Street America is scrambling to make their mortgage payments and put food on the table. Certainly those that donated the maximum of $30,800 to a national party committee would be considered among the "elite" or "one percent".

Here is a summary showing how much was raised by all of the Presidential candidates in total, the funds raised by each of two national parties and how much was raised by each of the Presidential race candidates in order from most raised to least:

Here's more detail showing where the pre-nomination raised funds came from (to June 30th, 2008) starting with the Republican primary candidates:

...and finishing with the Democrats:

Let's zoom in on the two final Presidential candidates, John McCain and Barak Obama. Here is more detail showing what John McCain's team raised, spent and had left over after the 2008 election:

Here is more detail showing what Barak Obama's team raised, spent and had left over after the 2008 election:

John McCain raised $206,590,868 from individuals and he received 59,934,814 votes meaning that each vote is associated with a measly $3.45 in individual receipts. Barak Obama raised $664,871,475 from individuals for the 2008 Presidential election and he received 69,456,897 votes meaning that each vote for Obama is associated with $9.57 in individual receipts. On the expenditure side, John McCain spent $367,838,967 excluding contribution refunds but including loan repayments. This means that, on average, his campaign spent $6.14 for each vote that he received. The Obama campaign team spent $754,613,607 excluding contribution refunds. This means that, on average, his campaign spent $10.86 for each vote that he received. The fact that both candidates spent $1.12 billion to win the "prize" is rather sobering, as is the fact that both men had incurred personal debts totalling nearly $2 million.

Now, I'd like to take a look at just how big an average individual donation is and just what proportion of American voters of both the Republicans and Democrats chose to vote with their wallets. According to the FEC website, Barak Obama and his Obama for America Committee raised a total of $664,872,382 from 688,750 individuals during the 2007 - 2008 election cycle as shown here:

This means that the donation to the Obama campaign from each individual averaged $965.00. Since he received 69,456,897 votes, it means that just over 0.99 percent of Americans who voted Democrat in 2008, donated to the Obama campaign.

Again, according to the FEC website, John McCain and his various election committees raised a total of $206,590,868 from 236,341 individuals during the 2007 - 2008 election cycle as shown here:

This means that the donation to the McCain campaign from each individual averaged $874.00. Since he received 59,934,814 votes, it means that less than 0.39 percent of Americans who voted Republican in 2008, donated to the McCain campaign.

I found it most interesting to see that less than one percent of those voters who voted in the 2008 federal election, actually donated to their favourite political cause. If we use the Census Bureau total number of eligible American voters (206.7 million) as a benchmark, only 0.45 percent of individual eligible American voters donated to a federal political party or candidate, a tiny fraction of the potential voting public.

Now, let's move to the current Republican race. Here is a chart that I used in an earlier posting:

You can see quite quickly that, to the end of the third quarter of 2011, a total of 54,026 Republicans have donated $82,502,949 to their candidate of choice. This works out to an average of $1527 per donor. If we take the number of Republican voters in the 2008 election to give us a reasonable idea of how many Americans could potentially vote for the Republican candidate in 2012, we see that only 0.09 percent of 2008 Republican voters have made a donation to the slate of GOP Presidential candidates. With the average size of their donation being in excess of $1500, I would suspect that these donors are among the "one percent". President Obama is not doing well at this point either; thus far, he has received donations from only 55,662 individuals, representing a tiny 0.08 percent of Democrat voters in 2008. While I realize that we are not yet in the thick of the two-party election cycle, it is interesting to see that a very insignificant number of Americans have considered making a cash donation to see that the Republican candidate of their choice is selected or that their Democratic President is re-elected.

Unfortunately, as this posting shows, Presidential election campaigns spend an unfathomably large amount of money, in fact, a billion dollar campaign is not out of reach for President Obama in 2012 despite the protestations of his campaign manager Jim Messina as shown here:

There is no doubt that it takes an unrealistically massive fundraising effort for campaign teams to get their Presidential candidate elected. What these statistics show is that there is an infinitisimally small proportion of Americans who vote with their wallets; just under one percent in the case of the Democrats and well under half a percent in the case of the Republicans in 2008. From the average size of the declared donations, it appears that only a certain select wealthy demographic can afford to make significant and meaningful political contributions to support the candidate of their choice. While campaigns like the small "mom and pop" donations, they LOVE the big donations. It's even more surprising to see that, despite the growing left-right chasm in American politics, such a tiny number of Americans support their political choice with a cash contribution. Maybe that's the one percent (or less) that the OWS demonstrators should be focusing on. After all, you can't run a campaign on hot air alone although you'd never know it! As well, when Main Street Americans sees the massive expenditures necessary to win the ultimate political prize in America, it should become quite apparent just how out of touch America's politicians have become. After all, not many ordinary Americans have first hand experience with seven, eight or nine figure numbers with a dollar sign in front of them, let alone when the money involved is voluntarily donated.

The World's Housing Markets: An Overview

2011-12-30T07:30:00.000-04:00

Scotiabank has released its Global Real Estate Trends research publication for December 2011 and it contains some very interesting data and observations.

The author, Adrienne Warren, opens by noting that four factors are working against the global housing market; the slow pace of the economic recovery, weak consumer confidence, high unemployment and the sovereign debt crisis. Of the real estate markets in the ten developed economies that Scotia bank tracked in the third quarter of 2011, average real home prices were below last year's levels in seven. The best performing market was Canada and the worst was Ireland with the United States coming in at seventh place and the United Kingdom coming in at sixth place. Let's take a more detailed look at several of the markets in the report.

1.) Ireland: Here is a graph showing Ireland's real house price index since 1992:

Ireland, the worst performer among the ten nations, saw its year-over-year housing market down by 14.7 percent in real terms, adding up to a cumulative drop of 44 percent from its highs in early 2007. This drop has pretty much negated the real estate price increases Ireland has seen over the past decade. Between 1992 and 2007, house prices in Ireland rose by nearly 330 percent, largely as a result of massive growth in the country's economy (recall the long-extinct Celtic Tiger?). This was both the biggest and longest housing boom. With a drop of 44 percent, Ireland has now seen the largest downward price readjustment, however, its house prices still retain the largest cumulative price growth among the sample nations suggesting that the correction may not yet be over. From the graph it is also apparent that the downward slope is still quite steep, suggesting that prices have not levelled.

2.) United Kingdom: Here is a graph showing the United Kingdom's real house price index since 1995:

House prices in the U.K. are declining again after a short-term recovery in 2010 with real home prices declining by 6.7 percent on a year-over-year basis. Over the period from 1995 to 2007, real house prices in the U.K. rose by 174 percent and fell 15 percent from the 2007 peak to the third quarter of 2011.

3.) Australia: According to Demographia, Australia’s major cities suffer from some of the world’s least affordable real estate when prices are measured in terms of household income. Australia’s median multiple (dividing median house price by median household income in that market) of 7.1 indicates that homes in the major centres are “severely unaffordablte. Between 1996 and 2010, Australia saw its house prices increase by 125 percent. The market suffered a 5 percent decline in 2010 on a year-over-year basis.

4.) United States: Here is a graph showing the United States' real house price index since 1996:

Between 1995 and 2005, the United States saw real price growth of 50 percent in its housing market. A sharp reversal in 2006 has resulted in cumulative downward price readjustment of 31 percent with a year-over-year drop of 7.5 percent in the third quarter of 2011. Unfortunately, a stagnant job market, oversupply of foreclosures and unsold homes and tight credit conditions have led to a very moribund housing market. Here is a graph showing the slump in the leading U.S. housing indicators:

With prices, home sales and housing starts moving sideways during 2011, one would think that demand for housing would be rising. Unfortunately as I noted above, that is not the case despite the fact that home prices are now among the most affordable as valuations have fallen below long-term trends. Weak income growth and weak employment gains are dragging the market sideways, resulting in consumers that are reluctant to purchase real estate. As well, an oversupply of housing has kept new construction growth at a minimum with the number of vacant homes alone standing about 600,000 above its long-term trend. One thing working in the favour of future housing price increases is the drop in American household debt levels as shown here:

Household credit has now fallen from its peak of 164 percent of household disposable income to 146 percent in the third quarter of 2011. While still high, this readjustment is a marked improvement and if the trend continues, it could provide a boost to the housing market as consumers feel that their financial situation is more stable.

On top of these factors, annualized new housing construction is just over 600,000 units. This is well below the long-term replacement value of 1.5 million homes per year. This has resulted in a record low level of unsold new homes. Should the aforementioned factors of employment, economic growth and household debt correct themselves, this dearth of new homes could quickly lead to a supply/demand imbalance which could push prices up quickly in some areas where there is not a massive inventory of foreclosures.

5.) Canada: Here is a graph showing Canada's real house price index since 1998:

In the period between 1998 and the present, Canada has not seen a downward price readjustment, in fact, among the nations in the study, Sweden, Switzerland and Canada are the only nations that have seen steady price appreciation with prices at or near record highs. Over that timeframe, Canadian real estate prices have risen by an inflation-corrected 85 percent, relatively small when compared to some of the European nations in the study. On a year-over-year basis, prices rose by 4.8 percent in the third quarter of 2011 with some leveling off of prices in November due to economic uncertainty. Canada’s housing boom is now in its 13th year, just behind Ireland and Sweden's 15 year boom.

Here is a graph showing how both the number of sales and how real estate prices in Canada have risen since 1990:

Let's just say that its been a good decade to be a realtor!

A great deal of this boom in Canada's real estate can be attributed to ever lower mortgage interest rates as shown on this graph:

Mortgage interest payments have fallen from just below 7 percent of household disposable income in the early 1990s to roughly 4 percent in 2011, largely due to the current ultra-low interest rate environment. The peak of 7 percent in the early 1990s was due to mortgage interest rates ranging between 14 and 15 percent. As mortgage payments as a percentage of household disposable income have fallen, purchasers have been lulled into thinking that the current low interest rate environment is the new norm and that their payments will never increase. With today's far higher real estate prices, mortgage debt servicing could well become an issue if interest rates rose to even half of their two decade peak. While Canada prides itself on its stellar banking industry, the balance sheets of Canada’s banks could look a bit less beautiful if interest rates rose and mortgage arrears rose in tandem.

While I realize that some of the issues facing the real estate markets in other nations are specific to the economies of those nations and that they are unlikely to impact Canada' real estate market, one should never say never. With Canadians facing record high household debt levels, the day of reckoning could be just around the corner if interest rates rise even modestly and consumer debt becomes less serviceable. No one thought that the United States' real estate market would crash in 2006 - 2007, did they? Apparently, they were very, very wrong.

Iran: An Oil Giant

2011-12-28T20:14:00.000-04:00

Back in late November, I posted an article outlining Iraq's contribution to the world's natural gas resource base. As you may recall, Iran is one of the world's leading producers of both natural gas and oil; it is OPEC's second largest oil producer and exporter after Saudi Arabia and, in 2010, was the world's third largest exporter of oil after Saudi Arabia and Russia. In this posting, I will be taking a look at Iran's oil industry, particularly since they have threatened to shut down the Strait of Hormuz, a very narrow body of water near the exit and entry point of the Persian Gulf through which passes 15 million BOPD or one-sixth of the world's supply of oil.

Iran is a founding member of OPEC. According to OPEC's website, Iran has the third largest oil reserves among the 12 nations that comprise the cartel as shown here:

OPEC's oil reserves of 1193 billion barrels make up 81.33 percent of the world's total oil reserves. Among OPEC nations, Venezuela has the largest reserves totaling 296 billion barrels and Saudi Arabia has the second largest at 264 billion barrels. With reserves of 151.17 billion barrels, Iran has 12.7 percent of the world's total oil reserves. Iran is OPEC's second-largest oil producer and the world's third-largest crude oil exporter (or fourth largest depending on the source).

Here is a map showing Iran's main oil and gas fields and pipeline infrastructure:

Iran has 40 producing oil fields, 27 onshore and 13 offshore with medium sulphur content crude and gravities ranging from 28 to 35 degrees API. Onshore fields comprise just over 70 percent of Iran's total oil reserves with over 50 percent of the nation's reserves confined to just six supergiant fields including its largest field, Ahvaz. The vast majority of the fields are located in the northwestern part of the country adjacent to the Iran-Iraq border. Data available from OPEC suggests that Iran exported approximately 2.438 million BOPD to Asian and OECD European nations; in comparison, the United States Energy Information Administration (EIA) estimates that Iran exported over 2.2 million BOPD in the first half of 2011. As of 2008, Iran was producing an estimated 4.3 million BOPD of which roughly 3.8 million BOPD was crude oil. At these rates, if no additional oil was ever discovered in Iran, the country's reserves would last for 95 years. In 2008, Iran consumed 1.73 million BOPD of its own production; these levels are rising as the population grows since most of the domestic consumption is related to the use of both diesel and gasoline. Here is a graph showing Iran's total oil production and consumption over the last 4 decades:

One of Iran's energy and fiscal problems relate to its high level of energy subsidy. In 2009, Iran's gasoline price was approximately 10 cents per litre. The Iranian government proposed removal of these subsidies which would have raised the price of gasoline to 40 cents per litre, a 400 percent increase. Here is a look at other proposed energy price changes which were announced in December of 2010:

Here is a graph showing how rapidly Iran's gasoline consumption rose over the past three decades:

Interestingly enough, this energy-rich country had imposed gasoline rationing which began in 2007. In the three years following rationing, the gasoline quota per individual was reduced from 120 litres per month to just 60 litres per month!

Just prior to the Iranian Revolution, Iran's oil production was in the 6 million BOPD range. Imposition of international sanctions and a high rate of decline in Iran's oil fields pushed daily oil production down to approximately 1.5 million BOPD by the early 1980s. This has since risen to around 4 million BOPD and it is estimated that in 2011, Iran's crude production has been in the range of 3.6 to 3.65 million BOPD, above its OPEC target of 3.34 million BOPD. Natural declines in Iran's aging oil fields are an ever-present problem; an estimated 400,000 to 700,000 BOPD are lost to natural declines on an annual basis. To combat this, Iran's oil fields require massive infrastructure investment including enhanced oil techniques using injection of the nation's massive natural gas resources to repressurize reservoirs.

Most of Iran's oil exports end up in Asia. Here is a chart showing Iran's top export destinations for 2010:

Iran's largest volume of exported oil is comprised mainly of Iranian Heavy Crude. In 2010, Iran's net oil export revenues were approximately $73 billion, providing roughly half of Iran's government revenues. For the first half of 2011, China, India, South Korea and Turkey have all increased their imports of Iranian crude as export volumes are reallocated to countries that have less stringent sanctions in place. Here is a chart showing how export levels by country have changed (increased for Asia (excluding Japan) and decreased for Italy) for the first half of 2011 as compared to 2010 above:

A number of new oil discoveries have been made in Iran over the past 2 years. The National Iranian Oil Company (NIOC) announced the discovery of light oil in the Khayyam offshore field in May 2011; the field has estimated recoverable oil reserves of 170 million barrels. As well, at the same time, Iran announced the discovery of new onshore oil and gas fields in the south and west of the country that contain an estimated 500 million barrels of oil.

Development of the infrastructure necessary to produce oil from new discoveries is hindered by international sanctions. The massive North and South Azadegan Fields (discovered in 1999) contain 26 billion barrels of proven oil reserves in a very complex reservoir. China, through its China National Petroleum Corporation (CNPC), is developing the north portion of the field. Japan's INPEX had signed an agreement to develop the southern portion, however, it pulled out of the project in October 2010 due to international pressures. Guess who stepped in? You're right - a subsidiary of CNPC! China has agreed to invest $8.4 billion over the next 10 years. As well, China's Sinopec has signed on to develop another promising field, Yadavarn, which should be producing up to 185,000 BOPD by 2016. Overall, according to FACTS Global Energy, Iran's discoveries of crude oil and condensate totaled 10.7 billion barrels of oil in 2010 alone.

From this posting and my posting on Iran's natural gas resources, you can see that Iran is most certainly key to the world’s overall energy picture. While they have become a pariah state in the eyes of many world leaders, their production contribution to keeping the world’s oil production levels at or above the overall level of demand cannot be denied. With that in mind, it will be interesting to see how long it takes before the leaders of the developed world take matters into their own hands and enact measures that will result in regime change, all in an effort to control Iran’s massive energy resources. As I've pointed out before, one thing will hinder their plans; it will take a massive effort to unseat China from their role as supplier of capital to the resource-rich pariah nations of the world.

The Government Accountability Office and Washington's Fiscal Future

2011-12-28T07:30:00.000-04:00

The Government Accountability Office (GAO) recently released its 2011 Financial Report of the United States Government. I actually like this report; since I have a business background, I find that it reads more like a corporate annual report. In this case, the Financial Report provides the President, Congress and Main Street America with a comprehensive look at how the Federal Government is (mis)managing taxpayer dollars by outlining the Government's financial position, its revenues, costs, assets and future liabilities.

Let's open with Timothy Geitner's introduction to the report:

"This report provides another sobering picture of our long-term fiscal challenges.".

That sounds, well, rather sobering, doesn't it, especially since it's coming from a former Fed President?

Here's a snapshot of the condition of America's finances at the end of fiscal 2011 compared to:

If you think of this as a report card for both the Presidency and Congress, one would have to think that any teacher would assign a letter grade of "F". Now, let's break down the data a bit further.

Here is a graph showing the United States' budget deficits and net operating costs for the past five years:

The budget deficits of fiscal 2010 and fiscal 2011 were nearly identical at $1.294 trillion and $1.299 trillion respectively; a slight increase in revenue for 2011 and a decreased net cost (due to a drop in costs for federal employee and veteran's benefits and a decline in the cost of economic recovery programs) led to a drop in 2011 net operating cost to $1.313 trillion, down from $2.080 trillion in fiscal 2010. Basically, it was the so-called "economic recovery" that reduced overall net operating costs; when the economy heads south again (as it surely will), net operating costs will rise as they did between 2007 and 2010 as government tosses more stimulus dollars into the pot.

The GAO is quite concerned about the long-term fiscal challenges facing the United States. Here is a graph showing the GAO's frightening fiscal projections for overall spending both including and excluding interest on the debt and revenue to 2086 as a percentage of GDP:

You will note the massive increase in net interest spending as time passes. The cost of the debt is expected to rise as a percentage of GDP even if both federal government spending and receipts remain at a relatively stable 20 percent of GDP. Net interest costs alone will ultimately reach over 15 percent of GDP due to increased debt levels, a scenario that is most likely unsustainable.

Now, let's look at government revenues for 2011. First, the level of corporate profits rose in fiscal 2011 but at a slower rate than in fiscal 2010. Despite the rise in corporate profits, corporate tax revenue dropped by $4.5 billion (or 2.5 percent) on a year-over-year basis as shown on this graph:

As I've posted previously, you will notice how corporate tax receipts declined in 2011 despite the fact that the economy was improving. As well, corporate tax receipts are less than half of their level in 2007, prior to the beginning of the Great Recession.

The level of personal income tax revenue rose by nearly $133 billion from fiscal 2010 to fiscal 2011, an increase of 7.7 percent. Personal tax revenue is now at 90 percent of its pre-Great Recession peak in 2008 compared to corporate tax revenue which is at only 48 percent of its pre-Great Recession peak in 2007. Perhaps corporations really do need a cut in the 35 percent levy! What I find interesting is the 7.7 percent year-over-year rise in personal tax revenue when one considers that the job market is hardly what could be termed as robust; U3 unemployment was stubbornly stuck in the 9 percent plus range all year and more comprehensive unemployment statistics showed unemployment levels well in excess of 15 percent as the Shadow Government Statistics website shows here:

Now, let's take a quick look at where Washington spent its windfall. Here is a pie chart that breaks down where government allocates your tax dollars:

The bulk of spending is in three areas, Department of Health and Social Services, Social Security Administration and the Department of Defense. Each of these consumes between 20 and 24 percent of Washington's revenue.

Here is a graph showing Washington's assets and liabilities:

Washington (or rather, taxpayers) owns about $2.707 trillion in assets comprised mainly of property, plants and equipment ($852.8 billion) with the remainder in paper including net loans receivable, those lovely mortgage-backed securities and other investments ($985.2 billion). The problem with government assets like property and equipment is that their value is often difficult to accurately assess; for instance, what is the value of a National Park and is there a even a market for such a property? On the liability side of the ledger, Washington has $10.174 trillion worth of debt securities outstanding (Treasuries plus accrued interest), Federal government employee post-employment benefits and veteran's benefits totaling $5.792 trillion and other liabilities of $1.526 trillion for total liabilities of $17.493 trillion. Doing the arithmetic results in net liabilities of $14.785 trillion. On top of this debt, there is intragovernmental debt which occurs when one part of the Federal government "borrows" from another; this debt totals $4.7 trillion. This represents government debt held by government trust funds including the Social Security and Medicare Trust Funds which are required to invest excess annual receipts in Federal government debt securities. Because these are liabilities of the Treasury and assets of the Trusts, they cancel each other out.

From the report, here is a graph showing the projected non-interest spending by the government for the next few decades:

The difference between non-interest spending and what the government takes in is termed the primary deficit or primary surplus. You will notice the black line showing Washington’s total revenue as a percentage of GDP; where the coloured portion of the graph rises above the black line, there is a primary deficit (remembering that the primary deficit excludes interest owing on the debt). The primary deficit soared in 2009, 2010 and 2011 as the government bailed out the economy (i.e. TARP et al). During those 3 years, the primary deficit reached nearly 10 percent of GDP both because of increased spending and decreased tax revenues. That is expected to drop to the point where there is a small primary surplus between 2015 and 2019 as the spending reductions in the Budget Control Act kick in. The primary surplus ends in 2020 as spending on Social Security, Medicare and Medicaid rise; the primary deficit is expected to peak at 1.3 percent of GDP in 2035. You will notice that this projection does not include the possibility of another Great Recession that would require a massive federal government bailout as was the case in 2009 - 2011. That is why the black line and the coloured areas are so smooth as we move into the future. Looking back, one can see that the recessions of the early 1980s, 1990s and 2000s resulted in far higher primary deficits than would have been projected prior to their arrival. The same holds for the future with one difference; the increased spending on entitlements will mean that the Federal government is starting from a primary deficit rather than a primary surplus, making the fiscal situation even more difficult to control.

As I mentioned earlier, the GAO is concerned about the changing demographic that will impact the fiscal picture in the future; America’s aging population will result in persistent growth in Medicare, Medicaid and Social Security costs. Here’s a quote from the report:

"Largely as a result of the provisions in the Budget Control Act of 2011,4 the fiscal outlook has improved. However, rising health care costs and the aging of the U.S. population continue to create budgetary pressure. The oldest members of the baby boom generation are now eligible for early Social Security retirement benefits and for Medicare benefits. In addition, debt held by the public continues to grow as a share of the economy; this means the current structure of the federal budget is unsustainable over the longer term." (my bold)

According to the Medicare Trustees' Report, spending on Medicare alone is expected to rise from 3.7 percent of GDP in 2011 to 5.6 percent in 2035 and 6.2 percent in 2085. The Hospital Insurance Trust Fund is expected to remain solvent until only 2024 after which time, tax income will only cover 90 percent of benefits, declining to 76 percent in 2050. Social Security costs are expected to rise from 4.8 percent of GDP in 2011 to 6.2 percent in 2035 and declining to about 6.0 percent by 2050. The Social Security Trustees' Report notes that the annual Old-Age, Survivors and Disability Insurance Trust Funds (OASDI) income will exceed annual costs until 2023 at which point it will be necessary to begin drawing down the trust fund assets until assets are exhausted in 2036. After funds are exhausted, tax income will cover only 77 percent of benefits in 2036 and 74 percent in 2085.

Let’s look at what happens to growth in the primary deficit as a percentage of GDP if health care cost growth is more rapid than projected:

If Medicare and Medicaid expenses grow just 2 percentage points faster than the GAO projects, the primary deficit (excluding interest on the debt) reaches 20 percent of GDP by 2085. This doesn't sound like much until you put the number into perspective. Right now, the entirety of Federal government spending as a share of GDP, once again excluding interest on the debt, is 22.6 percent. To put the deficit into dollar terms, the 75 year present value fiscal imbalance of this 2 percentage point increase in Medicare and Medicaid spending is a rather scary $66.5 trillion or just over 4 times the current level of the entire federal debt.

When we take all of this data into consideration along with projections for interest rates and GDP, here is what we end up with:

Over the next 75 years, the debt-to-GDP ratio is projected to rise to 283 percent, down markedly from the projections of 352 percent in last year's Financial Report, largely because of spending reductions called for in the Budget Control Act of 2011. While this may appear to be a meaningful improvement, a projection is just that, a projection. From the graph showing what happens when spending on Medicare and Medicaid increase by just 2 percentage points, you can see how sensitive the projections are to small increases in spending or declines in revenue.

The sooner Congress makes meaningful progress towards fiscal consolidation, the less painful it will be for America. If reform begins in 2022 rather than immediately (assuming an immediate reform of 1.8 percent of GDP), the primary surplus must be raised by 2.2 percent of GDP, by 2032, the primary surplus must be raised by 2.8 percent of GDP just to keep the debt-to-GDP level in 2086 equivalent to the level in 2011. The increased cost incurred by delaying is a result of rising interest on the rising debt level.

Let’s close this rather lengthy posting with one last quote from the report:

"If a higher debt-to-GDP ratio increases the interest rate, making it more costly for the government to service its debt and simultaneously slowing private investment, the primary surplus required to return the debt-to- GDP ratio to its 2011 level will also increase. This dynamic may accelerate with higher ratios of debt to GDP, potentially leading to the point where there may be no feasible level of taxes and spending that would reduce the debt-to-GDP ratio to its 2011 level." (my bold)

It's Not a Christmas Story But....

2011-12-23T15:39:00.003-04:00

...it's entertaining, nonetheless.

I just wanted to wish all of my readers, followers et al a Merry Christmas and Happy New Year. I'm not certain that I'll be posting any further diatribes over the Christmas break so I'll leave you with this rather interesting "Not Christmas" news item. I just thought that it would be a nice change to post something that wasn't quite so "intense", unless of course, you happen to be the lady involved.

According to this case report by Doctor Oliver Richard Waters that I found on the BMJ website (formerly known as the British Medical Journal), it seems that a 76 year old female presented with weight loss and diarrhoea. Other than that, she was in good health. She underwent a sigmoidoscopy (a rather fun procedure if you haven't had one!) and the physician noted that she had severe diverticulosis or small bulges in the inner lining of her large intestine. A CT scan of her abdomen showed a linear foreign body located in her stomach as shown here:

After questioning her further, the patient recalled that, 25 years earlier, while she was inspecting a spot on her tonsil with a pen, she slipped, fell and swallowed the pen. Her husband, a general practitioner, dismissed her story because x-rays done at the time showed up nothing. Her 21st century physician performed a gastroscopy (another one of those fun medical procedures!) and extracted a plastic felt-tip pen. The pen was subsequently removed and, surprisingly, still worked as shown here:

Notice that the first words that the pen "spoke" after seeing the light of day for the first time in 25 years was a much relieved "hello"?

Here is the summary of the case report:

"This case highlights that plain abdominal x-rays may not identify ingested plastic objects and occasionally it may be worth believing the patient’s account however unlikely it may be."

Once again, have a Merry Christmas and please keep all of those plastic pens away from your tonsils!

Canada's Hidden $80 Billion Public Pension Debt

2011-12-21T07:30:00.000-04:00

Some months ago, I wrote a posting about both federal and state pension plans, the funding gap between their current balances and their future liabilities and how this was going to impact American taxpayers who are on the hook for the shortfall. Thanks to the C.D. Howe Institute, a Canadian think-tank, we now have a brief entitled "Ottawa's Pension Gap: The Growing and Under-reported Cost of Federal Employee Pensions" which outlines how the issue will impact Canadian taxpayers. Let's dive in and see what the authors, Alexandre Laurin and William Robson, had to say.

Canada's public servants are beneficiaries of defined benefit pension plans (DB). Three of the largest federal government DB pension plans are provided to the Public Service, the Canadian Forces and the RCMP. On top of that, Members of Parliament and federal judges have special plans; those of MPs are considered by many to be the ultimate in gold-plated pensions since they qualify for the MP pension after just six years of service which they can collect at the advanced age of 55. How many of us could say that? According to the Canadian Taxpayers Federation, the current DB pension plan requires taxpayers to fork over $5.50 for every $1 contributed by any given MP. For your illumination, here is the Canadian Taxpayers Federation calculations for pensions and severance payments owing to the MPs that were defeated in the May 2011 General Election.

Back to the C.D. Howe brief. In the private sector, DB pension plans must calculate the difference between their future obligations and assets using actual market yields. Not so for public sector pension plans. Public sector plans are allowed to use made-up rates of return to value their plans. Unfortunately, generational lows in interest rates have made these assumed rates of return unreasonable, resulting in growing unfunded liabilities.

Let's take a look at the pension data supplied by the Canadian Government for fiscal 2010 - 2011 in its Public Accounts annual publication:

Canada's public sector pension assets total $54 billion in 2011, future accrued obligations total $213.3 billion and unamortized estimation adjustments total $13.2 billion for a total future liability of $146.1 billion. However, if one replaces the government's current smoothed liabilities of $213.3 billion with a fair value approach that better reflects market rates of return that are currently available. Right now, the government is using a real assumed rate of return of 4.2 percent (note, that's the nominal or posted interest rate plus 4.2 percent for inflation) on all fund assets for benefits that were earned since 2000. The government also uses a moving average of past nominal yields on 20 year federal bonds in its calculations, again, these rates are well above what one would expect in the past few years.

If an individual Canadian wanted to set up a pension plan that mirrored the plan available to Canada's public sector workers, they would have to index their savings to inflation. The best measure of this index is a Canadian government real return bond. This is where the problem crops up. As noted in the previous paragraph, Ottawa is using a real return of 4.2 percent; unfortunately, the actual return on the real return bond is now just over one-half percent. According to the Bank of Canada website, real return bond yields have ranged from a high of 3.76 percent in December of 2001, falling to 0.53 percent in December 2011 with an average of 2.07 percent over the 10 year period. Here is a graph showing all of the data:

We can now readily see that the 4.2 percent real return is highly optimistic. The C.D. Howe recalculated the assets that would be required to fund Ottawa's pension promises using a "fair value" 1.15 percent yield and finds that Ottawa's obligations would rise from $213.3 billion to $285.2 billion. If one subtracts a new assets fair value of $58.6 billion, the unfunded pension liabilities rise from $146.1 billion to $226.6 billion, a difference of $80.5 billion. If one substitutes the current 0.5 percent rate on real return bonds, the future funding shortfall is even greater. Since the Canadian taxpayer will ultimately be responsible for these shortfalls, the $80.5 billion should actually be added to Canada's debt. According to Statistics Canada's latest economic and financial data report, Canada's accumulated federal debt reached $568.140 billion as of September 2011. If we add in the realistically calculated unfunded public sector pension liabilities, the debt rises by 14.2 percent to $648 billion. Since, in fact, this $80.5 billion shortfall was accrued over a number of years, the surpluses of the past decade were actually smaller than reported and the deficits were larger. For example, the 2010 - 2011 deficit would have risen from its reported value of $31 billion to almost $47 billion, a rather significant change.

Another point of concern is the growth in the funding gap. Here's how the growing gap between reported pension obligations and the fair-value estimate has looked over the past decade:

The authors suggest that the Canadian government has two ways to fix this mounting problem:

1.) Eliminate the final-salary-based DB plan and replace it with a career-average-salary plan and eliminate the early retirement option.

2.) Raise contribution rates to ensure that actual money inflow matches entitlements.

In summary, the rising gap between Canada's public service pension assets and its future liabilities should concern every Canadian since we are all ultimately responsible for the shortfall. Just as Canada's private sector employees are looking to retire, they may find themselves paying much higher taxes to fund their country's public sector pensions. That will most likely be a terribly unpalatable prospect.

United States and Canada - More Pragmatic Debt Ratings

2011-12-20T07:30:00.000-04:00

Over the past few months, I am always amazed when I see how the world's major bond ratings agencies view the current level of sovereign debt. In particular, I have been shocked that the debt wall facing the United States has garnered very little in the way of a downgrade, perhaps a slap on the fingers with a wet spaghetti noodle at most. Thus far, the downgrade and warning have provided very little impetus for Congress and the President to meaningfully change their spend more and then tax less philosophy.

Fortunately, however, there is a very small ratings agency located in Jupiter, Florida, that takes a far more pragmatic view of America's debt problems. Weiss Ratings, an independent ratings agency, uses far tougher standards than other ratings agencies because they are primarily a consumer oriented agency, providing risk-adverse consumers with a means to better understand investment risk. They have a reputation as a very conservative ratings agency and use a different letter grading system that is more intuitive than a series of A's, B's and plus and minus signs. Weiss rates banks, insurance companies, and credit unions so that consumers can avoid depositing their hard-earned money with companies that are financially weak. Fortunately, Weiss also rates sovereign debt, the subject of this posting.

Here is a screen capture showing how Weiss's ratings scheme compares to Best, S&P, Moody's and Fitch:

As I mentioned before, Weiss's ratings scheme is far more intuitive since most of us passed through elementary school at one time or another and have very clear memories that E's and F's were very bad and were probably going to get grounded, D's weren't so hot, C's meant you had some problems that would require extra homework and A's and B's meant that you were doing well.

Here is a screen capture showing what Weiss's ratings mean:

Now let's get down to the specifics of Weiss's ratings for sovereign debt. Weiss analyzes data from the IMF and other government sources to determine a country's rating. They look at four factors:

1.) Debt Index: The debt index measures the country's reliance on debt and deficit financing in proportion to its population and the overall size of its economy.

2.) Stability Index: The stability index measure the country's strength in terms of its currency, reserves, status as a world reserve currency and default history.

3.) Macroeconomic Index: The macroeconomic index measures the long-term sustainability of the economy including GDP growth, unemployment and inflation.

4.) Market Acceptance Index: The market acceptance index measures the ability of the government to raise additional debt on the world's bond markets.

Here are their ratings for sovereign debt:

A - Excellent - The country's finances are in excellent shape with good budgetary and debt management. It has a strong economy with good ability to raise additional funds in global markets as required. Risks to bondholders relate to interest rate and exchange rate fluctuations only.

B - Very Good - The country's finances are in good shape with at least good scores in all four factors. Most risks to investors involve interest rate and exchange rate fluctuations as noted above.

C - Fair - The country's finances are in fair condition although in the event of adverse economic conditions, it may encounter difficulties in maintaining its financial stability. Investors in bonds from these countries face potential losses if there are sustained declines in the country's medium- or long-term government securities that exceed those that are strictly related to rising inflation. Losses could also be incurred from a serious decline in a nation's currency.

D - Weak - The country is in a weakened financial condition with poor results on at least one of the four factors. It could have a heavy debt load, inadequate reserves, poor economic growth or an inability to raise additional funds on the world's bond markets. Risk to investors includes the threat of default. Sovereign debt investments in C-rated countries should be considered speculative.

E - Very Weak - The country has very severe financial weaknesses that make investment in its securities highly risky. Investors face very high risk of loss of investment capital because of bond price declines, currency collapses or default. Sovereign debt investments in D-rated countries should be considered extremely speculative.

That's enough background. Now let's look at what Weiss has to say about the United States and Canada.

1.) United States: To open, Weiss quite clearly states that they are not big fans of the AAA ratings assigned by the major ratings houses to United States sovereign debt. Here is a quote:

"We believe that the AAA/Aaa assigned to U.S. sovereign debt by Standard & Poor’s (S&P), Moody’s and Fitch is unfair to investors and savers, who are undercompensated for the risks they are taking. An honest rating for U.S. government debt is urgently needed to help protect investors and support the collective sacrifices the U.S. must make in order to restore its finances."

Weiss definitely does not go out of its way to be kind to the United States. They rate United States' sovereign debt as meriting a grade of C, putting them in 44th place out of 47 nations in terms of its debt burden primarily because of its consistently large deficits, 32nd place for its international stability due to its low reserves, 27th place for economic growth because of the swings in its economic growth pattern and 6th place for its ability to borrow in the international bond marketplace, largely because the United States dollar is regarded as the world's reserve currency. Overall, the United States comes in 33rd place out of the 47 nations in Weiss's ratings "world".

Here is Weiss's summary of their reasoning behind their assessment:

"The C rating signals that the current fiscal condition of the United States government is far inferior to that implied by its AAA/Aaa rating from other agencies. At the same time, it means that the U.S. retains enough borrowing power in the marketplace to give it the opportunity to take remedial steps. Still, there are grave risks for policymakers and investors, including the possibility of a vicious cycle that includes severe declines in U.S. bond prices and the U.S. dollar.

Although our opinion of U.S. sovereign debt contradicts the AAA/Aaa rating assigned by the U.S. credit rating agencies, it is supported by a large body of new research published by governmental and international organizations. Moreover, in creating its sovereign debt ratings, Weiss Ratings ensures fairness by avoiding conflicts of interest and focusing exclusively on objective, quantifiable criteria without cultural or political bias."

Weiss feels that the AAA/Aaa ratings assigned to United States sovereign debt securities is misleading investors because it fails to warn investors of the true risk involved, meaning that investors are undercompensated for the risk that they are taking when holding United States Treasuries. Most importantly, Weiss also notes that:

"The AAA/Aaa U.S. debt rating has continually fostered political resistance and gridlock in Washington. If an appropriate rating had been issued years ago, it could have played a pivotal role in helping lawmakers and policymakers take earlier remedial steps." (my bold)

Perhaps Weiss is correct; until there is a meaningful downgrade in the rating of United States sovereign debt, action on the part of Washington will not be forthcoming. After all, until you are punished, you have no incentive to change your behaviour! One need look no further than the recent example of the Eurozone to see what has happened when the major ratings agencies downgraded the debts of several European nations by several steps at a time. Certainly, the Eurozone's problems are far from over but at least discussions are being held and modest headway is being made. The same cannot be said for the United States where vitriolic partisan politicking takes the place of meaningful fiscal change.

2.) Canada: Weiss downgraded Canada from C to C- on December 19th, 2011. Weiss states that Canada is expecting slower-than-expected economic growth and rising unemployment which will make it increasingly difficult for Canada's government to balance its budget. As well, due to close economic ties with the United States and Europe, Canada is in the line-of-fire and cannot possibly hope to sidestep the world economic slowdown as it relates to the Eurozone debt crisis. Weiss also notes that reduced government receipts will make it difficult to achieve fiscal balance. This assessment is not that far off from what Canada's Parliamentary Budget Officer noted in his appraisal of Canada's chances of fiscal balance in his most recent PBO Economic and Fiscal Outook in November 2011.

To put these ratings into perspective, Weiss rates Austria as a C+, Belgium as a C-, the United Kingdom as a C-, Turkey as a C-, Ireland as a D-, Spain as a D+, Portugal as a D+, Brazil as a C, Greece as an E and Australia as a C+. Austria, Belgium and Turkey have all noted declines in their ratings in recent months due to deteriorating conditions in the stability of their financial markets. It is interesting to see Canada and the United States dwelling in the Eurozone debt transgressors neighbourhood, isn't it? Weiss's A-rated nations include Switzerland, Singapore, China and Malaysia.

As a hobby economist, I really like the Weiss ratings system. Not only is it easier to understand for lay people, I think that it better reflects the true situation of the fiscal stability of both Canada and the United States. While the governments of both nations just love to strut about and proclaim that their debt has among the world's highest credit ratings, their grasp on reality is tenuous at best. Weiss's grasp of the real issues that will ultimately impact the creditworthiness of nations seems to be far more compelling. After all, one cannot go on making a dollar and spending a two dollars forever. The folks at Weiss seem to be aware of that fact. Unfortunately, our politicians do not.

America's Housing Boom and Bust - Who Is Really to Blame?

2011-12-19T07:30:00.000-04:00

At long, long last, the fine folks at the Federal Reserve have figured out who is to blame for America's multiyear housing market crash. No, it's not their own tempting policy of ultra-low interest rates and no, no one on Wall Street is to blame in any way. The answer to this pressing question is to be found in the Federal Reserve Bank of New York's Liberty Street Economics analysis entitled ""Flip This House": Investor Speculation and the Housing Bubble".

The authors, Andrew Haughwout, Donghoon Lee, Joseph Tracy and Wilbert van der Klauuw, begin by noting that the cause of the rise and fall of the housing market in the United States during the 2000s has been the subject of much speculation. Virtually all purchasers of homes use debt to purchase a home thereby allowing themselves to purchase a larger home than they could afford if they had to pay cash. Most borrowers are solely motivated as owner-occupants who intend to live in their homes but there is a class of residential real estate purchasers who wish to purchase homes as an investment. It is these homeowners that are more likely to walk away from their homes if the value of the home drops to a level below the value of the mortgage. These investors pushed prices up during the mid-2000s and then when prices started to turn down in early 2006, they defaulted in large numbers; a process that contributed to the intensity of the down cycle in the real estate market.

Here are two graphs which show the number of first lien mortgages (aka first mortgages by non-central bankers) held by individuals as a share of the total number of mortgages remembering that each property can only have one first or primary mortgage, noting that the four colours represent the number of first mortgages for borrowers:

From the left graph, you'll note that in 2006, nearly 35 percent of all first mortgages issued in the United States were issued to multiple residence owners. On the right graph, you can see the data for the "sun'n'sand" states of Arizona, California, Florida and Nevada showing that in 2006, nearly 45 percent of all mortgages were issued to multiple mortgage holders. It is these states that have seen the largest price "readjustments". As well, from 2000 to 2006, the number of multiple mortgage holders in the four states nearly doubled from 24 percent to 45 percent. What is shocking to me is the rapid growth in the number of consumers that held first mortgages on four or more properties (in purple); by 2006, nearly 10 percent of all mortgages in the four state area were held by consumers with four or more properties, up from 3 percent in 2000. That's a lot of house!

Individuals who invest in three or more properties are highly unlikely to ever occupy all three properties, in fact, during the early part of the decade, these owners were more likely to flip their properties relatively quickly as the real estate market rose. On top of their buy and flip modus operandi, these owners tended to make higher bids for houses since their intention is to sell as soon as they reach a modest level of profit and, as you may recall, it appeared that the rise in housing prices in the first half of the 2000s appeared to be a never-ending wealth creation machine. The fact that these borrowers intended to flip their investments quickly meant that they were more likely to shop around for cut-rate deals on mortgages, often using subprime credit to make their purchases as shown on these graphs and paying a very low downpayment:

Note the rise in the use of subprime credit as the decade passed, particularly in the four aforementioned states. Since these owners had very little money "in the game", they had very little to lose once the market started to turn down, making it very simple to just walk away and never look back. After all, one can't get homesick if it was never home, can one?

Now let's look at how these speculators did as the housing market started to correct on these two graphs, once again, with the same colour scheme representing the number of first lien mortgages:

When measured using mortgage delinquency, multiple mortgage holders tended to do well in the first half of the 2000s because house prices were on that uphill treadmill. Things rapidly changed in late 2006 and early 2007 when house prices started to drop. Multiple first mortgage holders across the United States were responsible for only 10 to 15 percent of serious delinquencies during the first half of the 2000s. This changed dramatically, and by the fourth quarter of 2007, multiple first mortgage holders were responsible for just over 30 percent of delinquencies. In the "sun'n'sand" states, multiple first mortgage holders were responsible for just under 40 percent of delinquencies. That's a pretty stunning number!

The authors of the study conclude that speculative real estate investors were more important for the formation and collapse of America's housing market than was first thought. The availability of ultra-low interest rates (particularly teaser rates), the use of minimal (or no) down payments and other creative financing obligations allowed unsophisticated American investors to buy the "dream" several times over. Unfortunately, as the market started to fold back on itself, not only were speculators driven out of the market, but honest American families who prudently put a 20 percent down payment on their dream home and paid their monthly "pound of flesh" were collateral damage as housing prices collapsed to lows not seen since the early part of the decade. Unfortunately, the Federal Reserve seems unable to see that they paid a role in this horror story; it is their policy of easy, nearly free credit that is in large part responsible for the genesis of the problem. That, and their pals on Wall Street who used subprime mortgages as a self-perpetuating revenue creating machine. It would appear that all of them have not learned their lesson as well.

The Future of Oil - 2010 to 2035

2011-12-16T07:30:00.000-04:00

Now that we've seen West Texas Intermediate prices flirting with the $100 a barrel mark yet again and OPEC maintaining its production level at 30 million BOPD, I thought that it was time to take a look at the latest World Energy Outlook (2011) from the International Energy Agency (IEA) and see what they predict for the world's energy markets, focussing on oil, for the next 25 years.

First, let's look at the 3 year chart for West Texas Intermediate noting the steady rise in price from the lows of late 2008:

Now, let's look at the 3 year chart for Brent once again noting the dramatic rise in price from the lows of late 2008:

The IEA opens by noting that energy demand is expected to rise by one-third between 2010 and 2035 due to population growth which is estimated at 1.7 billion people and average annual economic growth which is estimated at what appears to be a rather robust 3.5 percent. While slowing recent economic activity may have an impact on energy consumption over the coming years, over the 25 year period, it makes only a marginal impact on consumption growth. Here is a graph showing the increase in demand for various forms of energy over the next 25 years (in blue):

Notice that both natural gas and renewable forms of energy fulfill the largest portion of the increased demand for energy. The impact of renewables results in an overall drop in demand for fossil fuels from 81 percent of all energy used in 2010 to 75 percent in 2035.

Population and economic growth is uneven throughout the world with non-OECD nations comprising 90 percent of growth and 70 percent of growth in economic output. As a result, in the next 25 years, non-OECD nations account for 90 percent of the increase in energy demand. Two nations, China and India , account for 50 percent of the growth in energy demand as shown on this graph:

By 2035, China consolidates its position as the world's largest energy consumer, consuming 70 percent more energy than the United States despite the fact that its per capita consumption is less than half the level of the United States. Growth in energy demand for India is even faster than that of China as more and more of its rural citizens strive to reach the middle class and expect to share in the benefits.

Now, let's focus on oil. By 2020, China is projected to take over first place from the United States as the world's largest oil importer and by 2035, it is anticipated that China will import over 12 million BOPD. By 2035, 80 percent of the oil consumed in non-OECD Asia is sourced from imports, up from just over 50 percent in 2010. This is largely due to natural declines in domestic Asian production. By 2015, even the EU nation states will import more oil than the United States, largely because of rising U.S. oil output from tight formations (think fracking) and improved efficiency. Here is a graph showing the changes in oil imports for the next 25 years:

World oil demand is projected to rise from 89 million BOPD in 2010 to 99 million BOPD in 2035 despite improvements in fuel economy technology. While alternative fuels (i.e. electricity) are starting to appear in the transportation sector, it could take decades before new technology significantly impacts the use of oil as a transportation fuel. Here is an interesting graph showing the projected changes in the vehicle purchases by nation over the next 25 years:

The world's total vehicle fleet is projected to double in size to 1.7 billion vehicles in 2035 with most new cars sold in non-OECD nations by 2020. Notice the increased market penetration of vehicles in both China and India. As a result, non-OECD nations will become increasingly important to the oil demand scenario.

On the supply side of the oil ledger, conventional crude production is expected to remain constant before declining slightly to 68 million BOPD by 2035. Most oil will be sourced from the Middle East and North Africa (MENA), with the area accounting for over 90 percent of the required growth in output needed to maintain supply - demand balance. The IEA estimates that, to develop the productive capacity of the MENA region, an annual investment of $100 billion will be required. To compensate for production declines over the next 25 years, 47 million BOPD of gross production additions are needed; to put this into context, this is twice the volume of oil currently produced by all Middle East OPEC nations! This will require an investment of $10 trillion over the next 25 years. As a firm believer in Peak Oil, I would suggest that this reserve and production replacement scenario is highly improbable. With my background as a geoscientist in the oil industry, I find this graph from BP's Statistical Review of World Energy most compelling:

Note the non-descript grey line in the middle of the graph. That's the world's reserves-to-production (R/P) ratio. Note that since 1985, the R/P ratio has not increased despite the trillions of dollars spent on oil exploration and exploitation and the new technologies that have allowed production from ultra-deep water and ultra-tight formations. The world is on an oil treadmill with resource discovery staying just level with oil consumption. If not for the one-off reserve additions in Latin America, the situation would be far worse. As I stated above, the odds of adding an additional 47 million BOPD of new production to compensate for natural declines are rather low.

The IEA suggests that part of the increase in oil production required could be sourced from natural gas liquids (18 million BOPD by 2035) and 10 million BOPD from unconventional sources. As shown in this graph, the largest oil production increases are sourced from Iraq, Saudi Arabia, Brazil, Kazakhstan and Canada:

Additionally, 4 million BOPD of biofuels are required to balance the ledger, a scenario that will require massive subsidies by governments who will, at that point in time, already be handicapped by unserviceable levels of sovereign debt making that part of the scenario less likely to occur.

As I have noted in previous postings, it is demand from the non-OECD Asian nations that will drive the energy markets in the coming decades, particularly the world's oil market. According to the United Nations, 1.3 billion people in the world do not have electricity and 2.7 billion people still rely on biomass for cooking. As these people strive to reach the middle class over the coming years, their energy consumption will, quite naturally, rise in lockstep with their improved lives. This increasing demand will occur at the same time as the world's conventional sources of oil dwindle. My suspicion is that the looming scarcity of the one resource that led to the rapid industrialization of the world in the first half of the 20th century will also lead to the world's next major geo-political conflict, particularly as prices for fossil fuels rise to the point where we are all very uncomfortable.

More MPs Does Not Necessarily Mean Better Government

2011-12-13T20:16:00.000-04:00

Now that the Harper Government has passed the so-called "Fair Representation Act", let's take a look at a few Parliamentary statistics:

First, let's take a look at Canada's overall population and the level of representation compared to our neighbour to the south:

Canada's population (2011 Statscan projection): 34,532,000

Number of Members of Parliament: 308

Population base per Member of Parliament: 112,120

Number of Senators: 105

Population base per Senator: 322,800

United States' population: 308,745,538

Number of Members in the House of Representatives: 435

Population base per Member of the House: 709,760

Number of Senators: 100

Population base per Senator: 3,087,455

First, I do realize that the two systems of governance are entirely different, however, as we can quickly see, Canada has far more representation at both levels of government than the United States. In fact, the number of Members of the House of Representatives has not changed since 1911 when the population of the United States was only 91,972,266. Even though the American population has more than tripled over the last century, the number of Representatives has remained constant with a brief increase to 437 in the years between 1959 and 1963 when the States of Alaska and Hawaii were added.

On a Canada-wide basis, each Member of Parliament represents an average of only 112,120 people. In actuality, based on the 2006 Census, the number of constituents that an MP represents ranges from a high of 124,572 in the West Vancouver-Sunshine Coast-Sea-to-Sky riding to a low of 32,245 in the Charlottetown, PEI riding. Prince Edward Island is by far the most over-represented province with four MPs representing an average of only 33,824 residents each in 2006. Please note that I have excluded Labrador, Nunavut and the Yukon since they have huge areal expanses with very low population densities compared to other ridings. Looking back at the statistics for the United States, on average, a Canadian MP represents 15.8% (less than one-sixth) of the number of people that an American Member of the House represents and a Canadian Senator represents 10.5% (just over one-tenth) of the number of people that an American Senator represents.

Since each MP gets a base salary of $157,731 annually, an additional 30 MPs will cost Canadian taxpayers an additional $4.73 million each year in salaries alone ad infinitum or at least until the House adds even more or salaries and expenses rise. Each MP gets the same base salary whether they are "stars" sitting near the front row in the House of Commons or the dim bulbs vegetating in the back rows, playing with their Blackberrys rather than paying attention to the matters of governing Canada. Salaries are a small part of the total compensation package; expense allowances, 64 annual return plane tickets, staff and office expenses, committee fees etcetera for each of the 30 new MPs will cost the Canadian taxpayer far more than the base salary expense.

Let's look at how much Canadians paid for their MP’s other expenses from April 1, 2009 to March 31, 2010:

If we split the $142,606,961.87 evenly across the 308 MPs, each of our elected representatives spent $463,010 on average to travel, employ staff, dine, print ten percenters, lease office space etcetera. If we were to add 30 more MPs, Canadian taxpayers would be on the hook for an additional $13,890,000 in expenses alone and, once again, that's a forever expense. When the MP expense amount is added to the salary amount, Canadians will be shelling out an additional minimum of $18.6 million annually to be "better represented" in Ottawa. While I realize that $20 million is chump change compared to what our MPs are used to spending, as Canadian taxpayers, we earn all $20 million of those dollars one at a time.

Rather than adding additional Members of Parliament, I would suggest that changes to riding boundaries would have better balanced population distribution in each riding. For example, Prince Edward Island should have two MPs (and, for that matter, Senators) at most. Manitoba, Saskatchewan, Nova Scotia, New Brunswick and Newfoundland and Labrador are over-represented to a lesser degree and could easily have the ranks of their MP thinned and redistributed to the larger existing ridings. The same could be said for the rural ridings adjacent to the urban centres that have experienced rapid population growth.

Increasing the number of Canada's MPs will have no marked effect on the level of representation for the average Canadian. Ask yourself how often you actually see and interact with your MP in person. Does your MP even show up at your door during an election campaign and does he or she respond to your telephone calls, emails or letters in anything but a cursory manner? I suggest that it won't matter whether Canada's MPs represent 35,000 or 350,000 constituents; you will interact with them no more and no less with them than you do now. Your riding will be no better represented in the House if there are more MPs whiling away the hours in Ottawa.

In these times of huge budget deficits and growing national debt, more government is not necessarily better government. Our existing MPs just need to learn how to be more efficient workers for the people who vote them into office. That's a hard lesson that we've all had to learn.