I little industry news this morning to share with you. Now, think about it critically, and avoid the rather partisan result of the tables in judging a six month government inheriting a time of extreme fiscal crisis and simply look at the graphs without the colouring. What do you see that’s odd?

The History of Alberta’s Debt Position in Charts

I see a few. One, the current graph is basically exactly the inverse of oil prices. That would say for a province where only 25% of our GDP is tied directly or indirectly to oil, the vast bulk of the public services are funded by energy royalties. That’s not a stretch. The shortfall is very much a result of decreased royalties alone. Thus, no heritage fund, we were spending the variable income on our operational day-to-day costs. All so we had lower taxes. Our oil paid for our schools and health care.

Now, it can’t. so either we have to pay right now, go without them, or shift the operational costs, and find another way forward, or a mix.

Another item. Lougheed ran a pretty even keel. He had a net negative debt contribution, was in power for a very long time though some of the hardest times, and created what was once a huge heritage trust fund with our oil and gas royalties. That is what Notley plans to do with any additional royalties resulting from the current (and overdue) review. We are shifting, under the current government, some of our operational expenses back onto the tax base directly, and off the royalty base. That’s more sustainable, and more even keel over the long term. More what Lougheed was doing.  

Further, Klein is absolutely lionized by the fiscal hawks in Alberta.   The graph further lionizes him at a  glance and demonizes Notley.  But Klein absolutely hammered down the spending back then because, as is happening, our debt rating was downgraded.  There is merit to getting it under control and having a plan, but Klein also gutted our services that we pay for and rely on as citizens of this amazing province.   It wasn’t all wine and roses.   If you were in the queue for health care, it was a long suffering mess.   But why did he have to cut so extremely deep when Lougheed only had a net NEGATIVE effect on the debt for the many years previous to him?  And why are we lionizing the PCs when their last run of Premiers were in power only slightly longer than our latest new government and ran the debt up proportionally at a time of the highest oil prices in history?  Keynesian economics says you pay DOWN the debt in GOOD times and spend on stimulus and responsibly in the slow times as a government.   Both to even out the cycle and kickstart the next growth phase.   We are inherently poor at doing the former, only Finance Minister and PM Martin being one I recall doing so successfully and in a balanced manner.

I’m not one to give public services a free pass.  We need to help them and incentivize them to find ways to be better, and more efficient, whilst delivering higher quality services year over year.   That’s how a company runs, and is geared to run.   But it serves the people.   Not the economic cycle.   It needs to be there for everyone in good times and bad, not just when the oil prices are up.   That was what I consider to be a fatal flaw (in retrospect, unfortunately) of the thinking that has been prevalent in our province for the last few decades.   Short-term, immediate-gratification thinking.   I want lower taxes when times are good.   Don’t bother we with your “what happens if….?” questions.   It’s my money.   I want all of it.   Tax somebody else for my schools and roads and health care and….

Look at it another way.  We all want lower taxes.   Most of us have realistic views that a civilized and advanced society such as we live in has a significant infrastructure and operational foundation that needs to be funded, and isn’t really a money maker.   It’s an enabler for all of us for our business, pleasure, and lifestyles.   So we know there has to be some taxes there to have all this.   Otherwise everything just gears only to the wealthy, and society stratifies and stagnates.  It’s a common good.   So we pay, but we complain, and we watch to try to keep an eye on it when we can, and pressure the government on it.

Then we fall victim to populism, in that a government can “play the system” and give us what we want (Klein) as we love him, but we have painted ourselves into a corner.   The debt is there to be paid on our infrastructure, and we had to pay it in all the post-Klein years.   And we still don’t have a really efficient public services model.   The hyper-reorganization of the Alberta Health Board has been a fiscal and organizational disaster from the first one, and they just kept coming under the later conservatives.   There was no goal other than “consolidate”.  I always found that odd, as businesses have branch offices and divisions to more efficiently manage larger organizations, not a concentration of functions across groups in all cases.   There’s a balance, but these reorgs have been top-down bureaucratic disasters spawned, it seems, from management consultants with little vision, unclear goals and no parameters.

So, we want services, and we let the populist governments, the neoliberal governments, pay for it all via royalties and lower taxes.   First for everyone to a flat tax, then primarily on businesses over the last little while, expecting more…. what?   Jobs?   We had the lowest unemployment rate in the country by almost a factor of two.   So why were we going after jobs?   The surplus, if there was one (there wasn’t, according to the graph) should have gone into the Trust Fund.   The royalties should be going into a trust fund.   We should be paying for our services and working to make them better, and cheaper per person, learning from the best public health systems in the world and then applying Alberta know-how to get even better.   To lead.  But instead it’s all about taxes, and royalties, and investment, and jobs.

What about fiscal sustainability?   Do you get the impression we left that by the wayside when Peter Lougheed stepped down?   Klein brought in chequebook sustainability, but that was small-town economics.   Not three million people economics with a diversified economy.  It wasn’t a growth for the future.   It was a fiscal minimalism.   It has appeal, don’t get me wrong.   Small government can be a good thing.  In many ways we want them to provide public services, and only incentivize or deincentivize otherwise.   Protect the public and common good.   Provide the services for everyone, and put the fiscal parameters around the rest so industry can solve and come up with the best solutions.   Remembering the industry has a goal of profit only.   Not whatever the people or government may have in mind.   To make the profit align with the results we want as a society as much as possible.   And let them build the solution.

Now, I think our new government is scrambling a bit.   The oil price has fallen twice as far as even our flash premier Prentice had forecast in his doom-and-gloom disastrous early election.   I don’t care WHO was in power right now, Klein, Lougheed, Notley, Prentice, or the best financial or managerial wizard you could conceive of.   This is going to be a very hard situation to work through and improve.   If we can get past the blame and inference, and learn from the simple facts that are there in history, maybe we can get out of this partisan, nonsensical bickering, and get back to building a great province for everyone.  

Some food for thought.   Remember, comments are moderated, but if you post something meaningful, not spam, you will get whitelisted.   Otherwise we would all be reading trackback spam for the next great online business opportunity marketing viagra funded from Nigerian inheritances and government interact refunds.

Reading an NYT article http://www.nytimes.com/2016/01/09/business/dealbook/asia-china-renminbi-currency-devaluation.html?&moduleDetail=section-news-0&action=click&contentCollection=International%20Business&region=Footer&module=MoreInSection&version=WhatsNext&contentID=WhatsNext&pgtype=article

There seems to be an oddity that I haven’t figured out yet.   Later in the article, it talks of a front of worry for global investors:   A potential wave of currency devaluations among… South Korea, Singapore and Taiwan.   This would, for ForEx specialists say, put a damper on global growth expectations.   

This doesn’t add up entirely.   If these are primarily export-driven economies, and their currency devalues (I will put aside the fact they control the exchange rates, which is a distortion itself), should this not, as general macroeconomic theory would have it, encourage two behaviours?  Those being:

1. Make their goods less expensive for export, in other countries with stronger currencies, thereby shifting demand towards those goods and increasing the export volumes and thereby incoming revenue in trade
2. Make their domestic goods more attractive to their citizens, thereby encouraging domestic investment, domestic consumption and domestic growth, and discouraging imports, thereby strengthening the value of their currency over time?

It strikes me that this is how the market is supposed to work when it comes to ForEx effects on supply and demand, but the commentary of these investors seems to state that it either won’t, or it affects things in ways they don’t believe have value.

Assets would be CHEAPER in these countries with devalued currencies, which I would think would herald a buy opportunity for such globally exposed investors, if they are value investors looking at the long term.   The article goes on to say these countries “… have some of the most overvalued exchange rates on the planet…” which says this would be a natural, free-market rebalancing that these global investors should welcome unless they are ALREADY invested heavily in these countries, and such a move towards free market exchange rates or at least a rebalancing would damage their holdings.   

Given that, it would seem the commentary is out of self interest, and has little to no bearing on the actual global growth expectations, except that these people would be taking an on-paper haircut, and only based on the valuation of these assets in say US dollars.  This may lessen investment as they have lower asset values to spend and invest, but then, if the prices go down in these markets, doesn’t that then encourage the investment?   Isn’t this the tenet of microeconomics that gets applied to investment and market justifications ad infinitum?   It is a gross simplification and market inelasticities also distort the effects, but the fundamental theory is supposed to still apply, or these investors are selling us a bill of goods that includes various bridges over deserts when these mantras get imbued into populist thought and political policy.

The later notes by actual analysts makes sense to me.   The slowdown in China is not so much a cause as an indicator that the global economy has cooled.   I think a segmented comparison would be more useful and attempting to correlate the exports to the segments in the north american and world markets that are slowed as drivers (retail, probably many others) and which are not, as the American economy is in the lead again, so it would seem some of it is driving forward and perhaps it’s not all based on consumerism Wal*mart type expenditure?   There’s a gap there that isn’t, as usual, being examined by any mainstream media I’ve seen so far.

So, over-globalized?

This gives rise to a somewhat follow-on thought that is related, but not directly to the NYT article that formed the trigger for the post.

Is the push over the last thirty plus years for increasing globalization and the concurrent hyper-focus on that created a brittleness and over-exposure akin to the 2008 financial crisis, which, from a certain perspective, was created by chasing higher returns in a saturated market and creating value where there was none, and getting investment into that non-value to the point that when actual value needed to be realized, the chain collapsed on itself, also happened in global trade? 

Basically, the extreme rush to offshore in the late 90s and much of the 2000s most likely, given the speed of investment and information now, overshot the balance point, and probably by more than a little.   It was aided in overshooting the mark by these export economies, which includes India and others beyond the SE Asia PacRim countries, not having their exchange rates actually react to the growing costs and standards of living in at least some of their populace, and concurrently in the value of commerce going on in their GDPs vs. the rest of the world.  Thus when their currencies should have appreciated given a free exchange rate (something China should have experienced over a decade ago, not only recently), caused the value in these economies to be grossly distorted downwards and thus create an artificial value in offshoring to the point that the actual realization of that value isn’t there anymore.  Simply put, I am proposing that it should not cost as little as it does to manufacture in these countries, because their GDPs grew to the point that their exchange rates should have made their currencies stronger and investment in them less attractive.   

This presents a conundrum in my thinking though, as it is the investments already in place that are out of alignment.  They were bought at certain values, hypothetically, and have grown as the currencies were pegged to the dollar and they appreciated in value.   But the exports were buoyed along by the fact the Chinese renminbi was also pegged artificially, and thus the real market valuation was absent from influencing the economies.   

So now you have the renminbi, which was artificially low due to zealous and continuous capital spending in China, now facing a devaluation as an unintended consequence.   The economy is in a state of over-investment due to very loose capital management by China and the bank(s) there.   So investments have been made that really should not have been as there was no realistic possibility to have it paid back (sound like a mortgage-backed security parallel to you as much as it does to me?), so there are billions of dollars of companies, jobs, and exports that simply don’t make enough money to pay their loans or stay afloat.   So they should have gradually died off over the years as the costs went up in China.  But with the pegged exchange rate, they didn’t.  And if they all do now, you will have civil unrest the level which would make Tiananmen Square look like a church group picnic.  So China is stuck, and all those that ran headlong into the China craze rush are also, indirectly, stuck in very poor investment positions, as the renminbi now has to reflect the global economy and the Chinese economy, and in doing so, devalue the crap out of itself, the investments in China, and consequently take all these other export economies which were defended by the distortion in a counter-intuitive way down with it.

This is where I have more thinking to do unless someone can point me the way forward, as all of these economies should have their exports made more attractive by devaluation, but the global nature of investment has made it so ForEx exposure is now distorting the market adjustments because the money is coming from the stronger economies, and they don’t want those previous investments dropping in value, and do not have the same interest in new investments.   

Of course, if there were enough freedom and diversification in the investment market, what should happen is that NEW investors come in at these lower prices to buy in, and the existing investors either ride it out, average down by investing more, or take the loss and get out as the devaluation occurs (or in advance if they can, and sell to markets where their currency will not devalue in relation to the one in question).

The more this gets exposed, the less I think most people, and even investment analysts, understand the intricacies of an integrated global economy.   It’s not all wine and roses, and will not be without a world government and unified economic policy, which would be horrendous and inflexible, and evolve to be very inefficient.   The diversity is the value, and the pain.   it’s what drives things forward and makes it robust.  But when you bank on a current state and bet it all and do everything in your power to enhance and propagate it, you distort it, and its relationship to other states.   

Then you get a collapse rather than a gradual shift.   It’s the difference between investment bankers, and biological systems.   Biological systems are not fully optimized and efficient.   They are robust, inefficient, and most important of all, fault-tolerant.   That’s why species survive most catastrophes, and grievous injury and disruption, and our economic systems increasingly don’t.  They have the robustness optimized out.   That’s the risk that the investors want legislated away and bailed out, but it can’t be without creating new inefficiencies.  

Back to the article, as sums up at the end though, many of those investors were dollar-based, which supports my theory and they are looking to get out before it devalues any further, or starts to devalue rapidly.   The pegged currencies created a fragile, distorted exchange rate and concurrent investment environment.   Unwinding those situations at this point looks like it will be very painful for the emerging economies.