Canada's Place in the Global Economy

[Edward Campbell]

Here, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail, is some excellent advice for the new UK Prime Minister David Cameron which is equally applicable to Barack Obama, Nicholas Sarkozy and most other world leaders:

http://www.theglobeandmail.com/news/opinions/cameron-could-learn-from-the-grand-old-mans-passion-for-economy/article1569535/?cmpid=rss1

Cameron could learn from the Grand Old Man’s passion for economy
Gladstone preferred to let money ‘fructify in the pockets of the people’ rather than waste away in the public purse

Neil Reynolds

Thomas Huxley, the eminent self-taught scientist and one of the great intellects of 19th-century Britain, called William Ewart Gladstone, four times chancellor of the exchequer and four times prime minister, “the greatest intellect of Europe.” And Huxley was a critic. Beyond all argument, this great liberal champion of laissez-faire was a smart man. By the end of his more than 60 years in public service, he had acquired a personal library of 32,000 books; by his own reckoning, and he was precise in his records, he had read 20,000 of them. But he wasn’t merely smart. He was right. Democracy, he said, was a spendthrift affair. He governed accordingly.

More than any other British leader, Gladstone can instruct Prime Minister David Cameron on the way to pay down the national debt – yet win admiration and respect from a dubious electorate that doesn’t quite think he’s up to the job. With a few basic principles as his guide – all of them more practical than theoretical – Gladstone paid down the massive debt incurred in the Napoleonic Wars. With the same principles, Mr. Cameron should be able to take care of a smaller debt with relative ease.

Lord Morley, friend and biographer of Gladstone, wrote of the Grand Old Man’s “passion for economy, his ceaseless war against public profusion, his insistence upon the rigorous keeping of the national accounts.” Gladstone cut taxes repeatedly. He reduced or eliminated scores of miscellaneous taxes. Marginal rate cut by marginal rate cut, he lowered the country’s income tax rate (to 1.25 per cent). Given one more term in office, he probably would have eliminated it. (He was 84 when he delivered his final speech in the Commons.) He rescinded tariffs – often unilaterally. Indeed, by one count he abolished more than 1,000 of them – 95 per cent of Britain’s tariffs. He balanced the budget and, more often than not, produced large surpluses to pay down debt. He preferred, he said, to let money “fructify in the pockets of the people” rather than waste away in the public purse.

It’s no wonder that the British public came to adore “G.O.M.” – or, as his imperialist Tory opponent Benjamin Disraeli jealously pronounced him, “God’s Only Mistake.” Winston Churchill and Margaret Thatcher aside, it’s no wonder that most of his successors in the 20th century looked, in comparison, so very small and so very inadequate. Mrs. Thatcher, for her part, observed that the great Liberal statesman would have “felt right at home” in her Conservative party in the 1980s. Perhaps. By Gladstone’s standards, though, Mrs. Thatcher was spendthrift herself.

With its constant clamour for foreign wars, 19th-century Britain provided Westminster with plenty of plausible excuses for going back into deficits – temporarily, of course. Gladstone, though, permitted no borrowing to fund these episodic misadventures. For a live-or-die war, he would have gone deeply into debt. For optional wars, he made Britain pay as it went. For these wars, indeed, he raised taxes. Of the taxes he raised to finance the Crimean War (1854), Gladstone declared: “The expenses of war are the moral check which it has pleased the Almighty to impose on the ambition and the lust for conquest that are inherent in too many nations.”

In 1815, at the end of the Napoleonic Wars, Britain owed a debt equal to 250 per cent of its GDP, the highest level that the country has ever recorded. Ironically, a century later, post-Gladstone, it had paid down this debt (to a modest 25 per cent of GDP) – just in time to embark on the global wars of the 20th century. By this fiscal discipline alone, Britain survived. Without it, the country would never have made it through the First World War – nor the Second World War, either – without utter economic disintegration.

There are only four ways for countries to get out from under massive debt. They can inflate. They can default. They can pay down the debt over time. Or they can grow their economies at a faster pace – which makes the debt shrink in proportion to a country’s national wealth.

Gladstone’s genius was to repudiate the first two options as immoral and to embrace the latter two as practical. He produced fiscal surpluses and used them to pay down debt. He reduced taxes to promote a higher rate of economic growth. This two-track strategy produced incremental increases in revenue, which he used to finance the next set of tax cuts – which yielded more economic growth: a virtuous spiral that returned ever-larger revenues to the Treasury and which ultimately made Britain the wealthiest country in the world.

Britain is now on its way toward a national debt of Napoleonic proportions. The Swiss-based Bank for International Settlements, the bank that serves the world’s central bankers, calculates that Britain’s debt will eventually rise to 200 per cent of GDP. Mr. Cameron can handle it – provided he heeds Gladstone’s famous warning words: “Nothing that is morally wrong can be politically right.”

Gladstone was and Reynolds is right: democracy is a spendthrift. A strong, reliable currency is one of the government’s primary obligations to its people: see Thomas Gresham and the ‘restoration’ of a sound currency in Elizabethan England.

The idea of “optional wars” is interesting and one which we all ought to consider.

Finally, Gladstone was right again: inflating (debasing) the currency and defaulting on debts are immoral – but that will not prevent many countries, including some advanced, sophisticated democracies from adopting either or both options, as the USA is doing in 2010; growing the economy and paying down debt are the only proper courses for responsible governments and responsible countries/peoples.

 

[Infanteer]

Shows how far I'm outta the loop - I didn't even know there was an election in the UK.... ^-^

 

[Edward Campbell]

There are a few smart Liberals and the best of that lot, John Manley, gives some good, sound practical advice to, primarily, our provincial governments in this article reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Financial Post:

http://www.financialpost.com/story.html?id=3049694

No time for complacency, Manley warns
Balanced budgets ASAP

Paul Vieira, Financial Post

Published: Thursday, May 20, 2010

Policymakers must not become complacent and need to work to return to balanced budgets "as quickly as" possible to ensure stability in the post-global recession landscape, said John Manley, former Liberal finance minister and now head of the country's CEO council.

"It wasn't sheer luck that enabled our economy to perform comparatively well during the downturn," said the president of the Canadian Council of Chief Executives, according to prepared remarks he was to deliver before Toronto's Empire Club yesterday.

"The most important reason for our economy's relatively good performance over the past couple of years is that we entered the downturn in a position of fiscal strength."

Mr. Manley acknowledged, however, the task won't be easy, as interest rates are likely headed higher, and with a renewed focus on spending restraint.

"This will be an especially daunting challenge at the provincial level, where every government faces the same huge problem: a public health-care system that is chewing up about half their budgets, with costs that are growing at about 6% a year. This simply isn't sustainable: Governments know it, the opposition parties know it, and doctors, nurses and hospital administrators know it too," Mr. Manley said.

He warned policymakers would have a tougher time of it than his Liberal government of the mid-1990s. During that period, Ottawa benefited from a downtrend in interest rates once a credible fiscal plan was outlined, cuts in transfers to the provinces, and revenue from a relatively new 7% GST, which has now been reduced to 5%.

Policymakers have bragged about Canada's relatively healthy budget balance compared with the rest of the world. But Mr. Manley warned now is not the time to be complacent. Canada's debt-to-GDP ratio, at roughly 35%, is roughly half the Group of Seven average.

"Governments, like consumers, can spend money they don't have, but they can't do it forever -- and if they can't balance the books when times are good, they're going to be in big trouble when the going gets ugly," he said. "If they didn't know this already in Greece, they sure as heck know it now, because the banks just cut up their credit cards."

He added data indicate Canada's debt-to-GDP ratio doesn't look as sterling when unfunded government pension liabilities are accounted for. Once that's brought into the equation, it more than doubles, to 78% of GDP, "a much higher percentage of our productive capacity than you might think if you were only paying attention to the federal budget," he said.

Mr. Manley said he expects jurisdictions to raise taxes to make up for lower revenue, citing moves by Nova Scotia and Quebec. But he added he's encouraged by moves in British Columbia and Ontario to harmonize their sales taxes in an effort to collect more revenue but minimize the impact on business investment and savings.

The Liberal opposition has called on the Conservative government to stop planned reductions in corporate taxes to 15% by 2012. But Mr. Manley said those tax cuts need to proceed as planned.

"Canadians relied on a cheap dollar to make our goods more competitive in foreign markets, but those days are gone," he said. "To compete for investment today, with our dollar strong and growth in many of our export markets still weak, Canada needs a significant tax advantage."

pvieira@nationalpost.com

The cult of entitlement that another Liberal, Pierre Trudeau, imposed upon Canadians must, sooner rather than later, be abandoned. We, most of us, want good, affordable health care; we will have to pay more for it. We, Canadians, want good schools and universities for our children; we shall have to pay more for them. We, Canadians, want operationally effective and cost effective armed forces; we shall have to pay more that, too. And so on. We can have what we want if, Big IF, we are prepared to pay. If or when we decide we do not want to pay any more then we shall have to learn to make do with less. There are municipal and provincial governments and a national government, too, but there is only one taxpayer, or, rather about 15 million of us who pay, directly or indirectly (through e.g. corporate taxes), for everything: sewers, warships, hospitals and foreign aid.


Edit: added the "fair dealings" bit, which I forgot when I wrote this  :-[

 

[Edward Campbell]

More on how we fit into the global economy, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail:

http://www.theglobeandmail.com/news/world/g8-g20/news/harper-looks-to-china-for-g20-results/article1575089/

Harper looks to China for G20 results
PM courts Beijing as ally against global bank tax even as he presses China to spend more or lower trade barriers

Campbell Clark
Ottawa

Thursday, May. 20, 2010

Scratch the surface of Stephen Harper’s G20 agenda and you’ll find China.

Instead of the once all-important United States, China will, more than anything, determine whether the Prime Minister can claim success at the global gathering in June.

Mr. Harper is looking to harness China’s increasing clout in opposition to a global bank tax that’s supported by many of Canada’s wealthy allies. But he’s also pressing China to boost the world economy with spending, or by revaluing its currency, while Western nations tame debts.

The G8 revolved around relationships with the United States, but the G20 increasingly revolves around a core G2 of the U.S. and China. The Prime Minister’s agenda-setting this week demonstrated that.

On Wednesday, Mr. Harper dispatched ministers to voice opposition to a global bank tax in Washington, but also New Delhi and Shanghai.

His government is trying to enlist big developing countries to quash global bank-tax proposals, and China’s weight is key. Several Western countries that bailed out banks, including the U.S., France and Britain, have proposed their own taxes, and so have reason to want them to be global.

Mr. Harper pointed to places where allies could be found: emerging economies that also feel their banks didn’t cause the 2008 financial crisis, and so shouldn’t pay. Yesterday, Treasury Board President Stockwell Day met a senior Chinese official and reported he “fully identified” with Canada’s argument.

China has a long-standing grievance that power in international financial institutions such as the World Bank and IMF rests too much with Europe and the U.S.. It somehow fits with resentment at being asked to pay for a crisis created by reckless behaviour in those countries, said University of Alberta political scientist Wenran Jiang.

On another issue, however, Mr. Harper is siding with traditional allies to pressure China.

On Monday, he sent a letter to G20 leaders urging them to set deficit-cutting plans to prevent a new wave of financial instability triggered by fears of defaults, like the worries that hit Greece and threaten to spread in Europe.

A crucial point in the letter was directed at China. He preached co-operation so that deficit-cutting doesn’t derail economic recovery. “Care must be taken to design consolidation plans so they do not halt recovery but sustain it, while looking to countries with high savings to provide greater support for demand,” Mr. Harper wrote.

That was a way of saying China has to spend more, lower trade barriers, or increase the value of its currency to boost the world economy while Western governments cut. China, with low debt, massive foreign-currency reserves and high household savings, is the key high-savings country.

It’s not a new theme. G7 countries have been urging China to revalue its currency for years because its low value makes it easier for China to sell exports, and less likely that it will buy imports.

But China has resisted big change: its government, like others, is under pressure to create jobs, and it fears low-cost manufacturing jobs will be lost if its exports cost more.

The same force that makes Beijing a potential bank-tax ally – resentment at paying for a Western crisis – could heighten resistance. China’s government faces domestic pressure not to sacrifice Chinese jobs to foreign arm-twisting, Mr. Jiang said.

Western governments are tailoring the message: U.S. Treasury Secretary Timothy Geithner is now avoiding currency complaints and calling on China to lower trade barriers to allow more imports. China could also support the world economy by extending and expanding its stimulus spending, which has short-term benefits for Beijing.

Getting some mix of those changes is key to Mr. Harper’s own agenda for the G20. As with the bank tax, it shows that Mr. Harper, who is thawing bilateral relations with Beijing, now needs a China strategy on the world stage.

Despite our enviable fiscal position – relative to Europe and the USA, anyway – we are a bit player on the world’s financial stage and we need the big boys, America and China, to help us or, at least, to avoid hurting us.

The bank tax, favoured by Merkel and Obama and all the other dimwits, is bad policy and we must hope that China and India will side with us and shoot the Americans and Europeans down in flames. 

 

[Edward Campbell]

Here, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from Bloomberg.com is an important assessment from one of Canada’s most respected economists:

http://www.bloomberg.com/apps/news?pid=20601039&sid=a8advNgW4inI

Canada’s Fiscal Edge to Fade Without Tough Action: David Dodge

Commentary by David Dodge

May 25 (Bloomberg) -- The problems facing Greece, Spain and Ireland may lead investors to think Canada is free from fiscal worries. They should think again when looking ahead for the next few years.

Canada’s relatively sound position by international standards masks a structural deficit that is poised to resume growth later this decade unless governments find more permanent solutions to cutting expenses than in their latest budgets, and introduce new measures to durably boost revenue.

The global recession, and the fiscal stimulus programs introduced in its wake, substantially increased public debt around the world. Even before the recession, Canada had a structural deficit of about 1 percent of gross domestic product at the federal level and a roughly similar amount at the provincial level. Without action, these will rise over the decade as population aging leads to higher spending and slows the potential growth in government revenue.

While Canada’s deficits are considerably smaller now than they were at their peaks in 1992, when the country was emerging from another recession, the challenge of putting public finances on a solid footing is, in many ways, more daunting today.

Even with strong demand in the first quarter of this year, over the next three years, a host of factors will restrain growth: a relatively sluggish U.S. economy, a strong Canadian dollar, higher Canadian and foreign interest rates, a relatively high debt-to-income ratio for households, a cooling housing market, and the removal of the fiscal stimulus. We need to recognize that economic growth won’t restore fiscal balance, even temporarily.

Slower Growth

Moreover, government revenue is set to grow more slowly during the rest of this decade. Canada’s potential growth will decline as the aging population leads to a drop in labor force participation. Even if the trend of labor productivity growth picks up to 1.5 percent a year, (which would exceed its average rate during the 30 years before 2007) potential growth won’t likely exceed 2.5 percent in 2012-15 and 1.75 percent in 2016- 20.

If we assume 2 percent inflation and moderate gains in the terms of trade from higher commodity prices, this means the trend of Canadian nominal GDP growth would be around 5 percent in 2012-15 and 4.5 percent in the second half of the decade.

The outlook on the spending side of the ledger is also grim, given demographic realities. Without severe restraint, total program spending will rise faster than revenue. In particular, health spending is poised to grow much faster than general revenue with the increasing proportion and aging of seniors. Since the health envelope makes up such a large fraction of total program spending -- 40 percent or more -- spending will rise faster than revenue over the decade even if other program spending rises much more slowly.

Spending Restraint

Debt-service payments also will increase faster than nominal GDP as interest rates rise to more normal levels and government debt keeps growing as long as deficits prevail.

Unless governments act to restrain spending and increase revenue beyond the short horizon of their latest budget initiatives, structural deficits are bound to start growing after 2012.

Can Canadian governments balance their budgets by mid- decade with program spending cuts alone? It would mean a significant reduction in services or income-support programs, even if there were unprecedented productivity gains in public services. Specifically, it would require significant cuts in public-pension payments, employment-insurance benefits and welfare payments, health and long-term care coverage as well as increased co-payments. The quality of education, and investment in roads and public transit also would decline.

More Radical

These cuts would need to be both continuing and more radical than those of the mid-1990s. Moreover, with population aging set to continue in the 2020s and 2030s, further service and transfer payment reductions will be needed.

In my view, achieving balanced budgets through lower spending alone simply isn’t possible; we need more revenue. The key is to do so in a way that has the least negative impact on incentives to work, to invest and to increase productivity.

What this means is higher consumption taxes with appropriate refunds to low-income groups, as Québec and Nova Scotia have proposed in their latest budgets. It also means introducing or increasing fees for services associated with roads, health care and post-secondary education, spurring efficiency both in production and use.

Balancing revenues and expenditures over the decade won’t be easy. But it must be done if Canadians are to enjoy rising incomes in the years ahead. In their 2010 budgets, governments largely failed to set out credible plans to achieve fiscal balance, though Québec began to address the medium-term issues. The federal and provincial governments shouldn’t fail to do so in 2011.

(David Dodge, former governor of the Bank of Canada, is a senior adviser at Bennett Jones and co-chair of the market monitoring group at the Institute of International Finance. The opinions expressed are his own.)

To contact the author of this column: David Dodge atdodged@bennettjones.com

Last Updated: May 24, 2010 21:00 EDT

I’m guessing that Dodge is right, that reduced spending alone will not work because governments will not cut deeply enough. The plural is important because even if we had a properly conservative government that would cut and cut some more just because they enjoy cutting programme spending (see: here), there are too many free spending Liberal and NDP administrations.

I reiterate my favourite solution: a nice, green carbon tax, paid, in full, by all of us consumers every time we heat our homes, drive our cars, buy food or watch our big screen TVs. We could, I believe, accomplish important economic goals quickly, and we might even do something good for society and the planet, en passant.

 

[Edward Campbell]

Here, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail is a good explanation of the EU+ version of the stupid economically unsound Tobin Tax and the good reasons why Canada opposes it:

http://www.theglobeandmail.com/news/world/g8-g20/opinion/canadas-global-bank-tax-stand/article1549315/

Global bank tax? More like a tax on customers
Canada was right to stand firm against the G20 levy

Neil Reynolds

Tuesday, May. 25, 201

The G20 – or rather, in this instance, the G20 minus Canada – wanted to impose a global tax on banks. Finance Minister Jim Flaherty quietly said that Canada, for its part, would do no such thing.
“Canada will not go down the path,” he said, “of excessive, arbitrary or punitive regulation of the financial sector.” Mr. Flaherty, unequivocal and unapologetic, marked an important advance in Canada’s slow, incremental return to economic maturity. It stands as Canada’s finest hour – in the last few weeks, at least.

Confronted with Canada’s dissent, the G19 caved – proving again the power of one when it holds firmly to principle. Canadian banks did not contribute to the market meltdown. Since they didn’t, they should not be treated as though they did. Let the G19 impose the tax as it wished. Without it, Canadian banks would gain competitive advantage and, all else being equal, would extend Canada’s growing reputation for fiscal integrity.

It goes without saying, of course, that the global bank tax was not exactly what its proponents said it was. The proposed G19 tax, in somewhat different guise, traces back to Nobel Prize-winning economist James Tobin’s proposed global currency tax of the 1970s. In turn, the Tobin currency tax traces back to John Maynard Keynes’ proposed Wall Street speculation tax of the 1930s.

Regardless of the differing formulas, the purpose of all such taxes is precisely what Prof. Tobin (who died in 2002) said it was – “to throw sand in the wheels of the financial markets, to end the dictate of the financial markets.”

When French President Nicolas Sarkozy grandly proclaimed “the return of the State” the other day, he was expressing the same strategic objective that motivated Louis XIV: government control of the financial markets – and the final taming of the shrewd.

For his part, Prof. Tobin described himself explicitly as “a disciple of Keynes.” But, as many contemporary Keynesians forget, Mr. Keynes himself – when it mattered – was himself a disciple of dictatorships. In his essay Keynes, the Man, U.S. libertarian economist Murray Rothbard recalls that Keynes was an enthusiastic supporter in the 1930s of Sir Oswald Mosley, the founder of British fascism, and that Keynes consistently championed the fascist economic model. Writing in 1939, in the foreword to the German edition of The General Theory of Employment, Interest and Money, his manifesto, Mr. Keynes conceded that his economic theories “adapt more easily to the conditions of a totalitarian state … than to the conditions of free competition.”

In fact, the world is now awash in Keynesian proposals to levy taxes on financial institutions and transactions – excluding only the central banks that contributed much to the excesses of the markets. These taxes are always proposed, initially at least, at a low rate. (Prof. Tobin suggested that his currency tax be levied at a rate of 0.5 per cent, or 50 cents on every $100 conversion.)

The global Robin Hood tax, an alternative levy proposed by philanthropic progressives, proposes a very tiny tax on selected financial transactions – a mere 0.05 per cent. Although nominally teeny, the tax would generate $650-billion (U.S.) a year for starters – half of which, advocates say, would be turned back to governments, half divided among global-warming programs and foreign aid to poor countries. In its report on the G20 global bank tax, the IMF noted discreetly that the tax could be gradually broadened to include insurance companies.

The proponents of these taxes make no effort to hide the fact that they regard them as a vindictive comeuppance for the rich. This is illusion. In the end, taxes trickle down to middle-class workers who are not able themselves to pass them further down. As Roaring Twenties President Calvin Coolidge put it: “No matter what anyone says about making the rich and the corporations pay, in the end all taxes are paid by people who toil.”

In his own assessment of the global bank tax, Royal Bank of Canada CEO Gordon Nixon essentially confirmed Mr. Coolidge’s analysis – saying that banks would, if necessary, pass the cost on to their customers. Indeed. What else would anyone expect them to do? For companies, taxes are a cost of doing business. When this cost rises, companies seek ways to suppress other costs (by cutting wages, for example, or by raising fees, or laying off workers or reducing services). The Massachusetts Institute of Technology’s Simon Johnson, a liberal U.S. economist, agrees that these global taxes would simply get passed down: “A financial transaction tax is more a tax on regular people, like you and me, than on anyone else.”

In all of this palaver, no governments are yet discussing reductions in spending – which could achieve the same fiscal objectives as any number of new taxes, domestic or global. According to a working paper published last week by the European Commission, just before the G20 finance ministers met, the most important fiscal fixes right now are “reductions in expenditures and reform of existing tax systems.” This report asserted that governments could accomplish more by cutting spending (on average, by 6 per cent) than by a global bank tax. Alas, governments rarely embrace restraint – and never ever on themselves.

It is good to see Canada standing firmly, albeit alone, on the right side of an important, global, strategic issue. America and Europe are led by populists and economic amateurs. We have to hope for maturity and leadership from Asia, especially China. In any event, even if the G19 decides on one thing we must, resolutely, do the other. We do not want to enter the fetid fiscal swamps with America and Europe.

 

[Edward Campbell]

Here, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail is more solid analysis and advice:

http://www.theglobeandmail.com/news/opinions/prudent-perhaps-but-the-canadian-model-pays-off/article1585057/

Prudent, perhaps, but the Canadian model pays off
What the rest can learn from what some have called the world’s soundest financial system

Kevin Lynch

From Saturday's Globe and Mail
Published on Friday, May. 28, 2010

While the world economy is now recovering from the first global financial crisis since the 1930s, the global debate on how best to present a reoccurrence is anything but settled. Financial reform proposals in the United States, the European Union, Britain and elsewhere present quite different views on how this core sector should be regulated, with the battle over a proposed bank tax being a prominent example. In all this, as a recent Financial Times article observed, “Canada is a real-world, real-time example of a banking system in a medium-sized, advanced capitalist economy that worked. Understanding why the Canadian system survived could be a key to making the rest of the West equally robust.”

Although Canada was hit by the worldwide recession, the Canadian financial system weathered the global financial crisis comparatively well. Canadian financial institutions were not unscathed by the crisis, but none were excessively affected by toxic assets, no public funds were injected into financial institutions, Canadian banks remained profitable and they continued to lend.

The sharp contrast between the Canadian experience and how negatively the financial crisis affected the United States, and much of Europe, reflects different regulatory regimes, as well as different corporate governance systems, financial institution lending practices and different structures. Interestingly, in the halcyon years before the financial crisis, Canadian practices were often criticized in New York and London as being too conservative, too prudent and too unwelcoming of the new financial innovations that were sweeping global balance sheets.

Canada has integrated regulation of banks, insurance companies and large investment dealers. The head of the Office of the Superintendent of Financial Institutions (OSFI), Canada’s regulator, regularly meets the largest financial institutions, to make sure that they are governed so as to be sound and stable. Canada allows securities firms to be bank-owned, and OSFI regulates the banks on a consolidated basis (retail, commercial, investment and wealth activities) worldwide, in contrast to the regulatory silos in the United States. The Canadian regulatory approach is both prescriptive and principle-based. This combination puts the onus on a financial institution to assure itself that it has met the intent of the legislation, in addition to what is explicitly prescribed.

Canadian financial institutions were less highly leveraged than their international peers in the precrisis period. This reflected the fact that Canada has a regulatory cap on leverage at an asset-to-total-capital ratio of 20 to 1. As a result, major Canadian banks had an average asset-to-capital multiple of 18 in 2008, while the comparable figure for many U.S. banks was more than 25, and numerous European banks were well over 30.

Capital requirements for Canadian financial institutions were above international standards, and Canadian banks typically maintained capital above these minimum requirements. Further, Canadian banks rely more on depository funds than on wholesale funding, compared which banks in many other countries, which provides more stability in times of market volatility.

A key asset class that fuelled the global financial crisis was subprime mortgages. The vast majority of Canadians mortgages are originated by banks to be held, thereby providing a “front-line” incentive not to lend where there is a high risk of default; unlike the U.S., where the majority were originated to be sold. In Canada, this is further buttressed by government regulations that require insurance for high-ratio mortgages and higher credit standards on the eligibility for mortgage insurance.

This financial-sector framework has to be overlaid on a Canadian economy with strong fundamentals: a decade of sustained government surpluses, solid corporate balance sheets, low and stable inflation, low net foreign indebtedness (less than the U.S.), the lowest net government debt as a proportion of GDP among the G7 countries, and an actuarially sound national pension plan. Taken together, this combination of macroeconomic management, regulatory systems, corporate governance structures and banking practices has produced what the World Economic Forum rates as the soundest financial system in the world.

As world leaders contemplate global financial reform, there are lessons to be learned from Canada’s experience and principles for reform to be drawn from the Canadian approach.

First, macroeconomic behaviours and microeconomic systems don’t exist in splendid isolation from each other. Prudent, long-term, fiscal and monetary policies are beneficial for financial sectors; conversely, macroeconomic policies that contribute to imbalances will eventually infect financial markets, no matter how sound the regulatory systems.

Second, globalization, together with the pervasive interconnections among markets it has spawned, has to be better understood. This should inform both the structure and operation of regulatory systems. It requires getting the “perimeters of regulation” right: sufficiently broad to avoid regulatory arbitrage, sufficiently comprehensive to cover all systemically important firms, sufficiently “smart” to allow firms to intermediate efficiently, and sufficiently “simple” to avoid excessive complexity and uncertainty.

Third, prudence may be boring, but it pays off, particularly when viewed over the complete economic cycle. Regulatory systems and business planning should be based on business cycles as the norm; they should not presume benign economic growth. The value and effectiveness of safety-net systems, whether they are financial-system capital requirements or economy-wide programs, have to be evaluated over the complete cycle.

Fourth, regulatory systems can’t be the first line of defence in our complex, decentralized, market-based system, and they can’t be exclusively prescription-based. That first line of defence has to be at the level of the firm, and imbedded in its corporate governance structures, procedures and values. Regulatory systems have to be both principle-based and prescriptive, and put the onus on firms to manage for safety and soundness as a principle, as well as meeting the required rules. This is the regulatory equivalent of general anti-avoidance legislation in the tax system.

Fifth, financial-sector reform needs to increase the quantity and quality of capital that financial institutions are required to hold, but it also needs to address the problem of pro-cyclicality, which is a feature of current regulatory systems. Pro-cyclical regulatory systems effectively require more capital in downturns, when you actually could use the capital buffer, leading to deleveraging and exacerbating the economic cycle. One solution is to take a complete-cycle view of appropriate average levels of regulatory capital, and allow additional capital accumulation during the expansion phase that can be drawn down during the contraction phase.

Sixth, there is much consideration being given to the twin challenges of systemic risk and moral hazard. Some argue that the solution to “too big to fail” is more functional separation of what a financial institution can or cannot do; others make the case that more consolidated risk management and strengthened regulation, including higher capital requirements and greater transparency, are more practical ways to proceed.

In seeking the right balance, policy-makers need to bear in mind that the lack of regulatory oversight on financial activities such as over-the-counter trading, hedge-fund positions and counterparty-risk concentrations played a role in the financial crisis, and that a more comprehensive and consistent regulatory environment should be the end objective.

Seventh, we need to move to a more effective stage of international regulatory co-operation. The financial crisis made self-evident the necessity for reform of national financial systems. But it also underscored the requirement for greater harmonization across national financial systems in a world of pervasive globalization, and the need for more effective international co-operation.

Eighth, on governance, the G20 took the lead in organizing the international response to the global financial crisis. They designated the G20 as the key forum for international economic co-operation, and agreed to a framework for financial-sector reforms. But while this complex international process unfolds over the coming months, the risk is that the urgency and cohesion of 2009 could give way to complacency as the recovery strengthens and to a reassertion of policy differences among countries. Neither development would serve the global economy well. Now more than ever, markets and consumers want signs of concrete progress, and financial institutions need certainty about the reformed system and its rules.

The financial crisis provides the impetus to learn from what went wrong, and to introduce reforms that will make such crises less likely and less traumatic in the future. It will be important to learn these lessons well. Canada, both as chair of the 2010 G8 Summit and co-chair of the G20 Summit, has the opportunity to play a leadership role in an effective reform process. Canada’s unique experience in avoiding the worst of the financial crisis gives it the credibility to lead.

Kevin Lynch is vice-chair of BMO Financial Group and former clerk of the Privy Council and secretary to the cabinet.

There is plenty of credit to go around in Canada: Mulroney, Chrétien, Martin and Harper all get some of it. But so do the apolitical central bankers, like Dodge and Carney and a succession of skilled bureaucrats, not least Lynch himself.

One hopes that our Canadian delegation to the G8 and G20 will heed Lynch’s counsel: we need to part of a global solution but, at the same time, we must not join a global solution that does not adhere to Mr. Lynch’s principles – which none of the EU, UK or US proposals do. None of the EU, UK or US proposals are sensible or acceptable; all must be rejected; let’s hope and pray for some leadership from Canada and some support from China and India.

 

[a_majoor]

An unstable Euro has all kinds of consequences, most are not good:

http://pajamasmedia.com/blog/what-would-a-euro-collapse-mean-for-the-united-states

What Would a Euro Collapse Mean for the United States?

Posted By Soeren Kern On May 31, 2010 @ 12:00 am In Column 2, Europe, Germany, Greece, Money, Politics, Spain, US News, World News, economy | 11 Comments

Amid growing fears that the Greek debt crisis may engulf Spain, Portugal, Ireland, and even Italy, prominent voices in the European Union and elsewhere are positing an idea that just a few months ago would have seemed inconceivable: the European single currency is in danger of collapsing.

The minority view has always been skeptical about the wisdom of merging the economies and currencies of 16 European countries that have different languages, cultures, economic stages of development, and social practices. Up until just recently, however, the EU’s politically correct thought police had effectively silenced public debate about the “European project” by branding critics as anti-European traitors [1].

But European officialdom is now reeling from an outbreak of apostasy within its own ranks. The chief heretic is German Chancellor Angela Merkel, who in recent weeks has said publicly what many have been speculating about privately: “The euro is in danger. … If we don’t deal with this danger, then the consequences for us in Europe are incalculable,” Merkel recently told [2] Germany’s Süddeutsche Zeitung. She repeated the warning in a speech to the German Bundestag [3]: “The current crisis facing the euro is the biggest test Europe has faced in decades. It is an existential test and it must be overcome … if the euro fails, then Europe fails,” she said

Merkel’s fears have been echoed by European Central Bank President Jean-Claude Trichet [4], who told the German newsmagazine Der Spiegel that these are “dramatic times” for the euro and “the most difficult situation since the Second World War, perhaps even since the First World War.”

Italian Prime Minister Silvio Berlusconi [5] told fellow European leaders in Brussels that the euro is in a “state of emergency.” (Berlusconi once said that the euro “screwed everybody [6].”)

Meanwhile, French President Nicolas Sarkozy [7] is said to have threatened to pull out of the euro altogether unless Merkel agreed to back the EU’s giant €750 billion bailout. The threat was reported by Spain’s El País newspaper, which attributed the information to Spanish Prime Minister José Luis Rodríguez Zapatero. El País reported that Sarkozy “banged his fist on the table and threatened to leave the euro, which obliged Angela Merkel to bend and reach an agreement.”

By publicly second-guessing the euro in such existential terms, European leaders have inadvertently drawn attention to many of the design flaws built into the single currency. This, in turn, has accelerated the euro’s depreciation in recent weeks and called into question its reliability as a reserve currency. The speed of the euro’s reversal of fortune is startling, especially considering that just a few years ago economists were predicting [8] that the euro would challenge the U.S. dollar’s status as the world’s dominant international currency.

As the debate over the future of the euro gains momentum, the question arises: How would the collapse of Europe’s single currency affect the United States? The demise of the euro (which may or may not be imminent) would have both negative and positive consequences for America in two broad spheres, namely in economics and geopolitics.

Economic & Financial Consequences:

In assessing the effects of a potential collapse of the euro, timing is everything. A sudden disintegration of the euro due to financial panic on international markets would almost certainly increase the risk of financial contagion spreading to the United States, especially in light of America’s $12 trillion debt load. In the ensuing turmoil, American banks could stand to face billions or possibly trillions of dollars in losses on their credit exposure to Europe, and thus call into question the solvency of the entire American financial system. At a very minimum, economic and financial chaos in Europe would severely disrupt American exports to Europe, and thus slow the economic recovery in the United States.

On the other hand, in a controlled break-up of the euro (a scenario whereby Germany tires of its role as EU paymaster and makes a policy decision to exit the single currency and reinstate the Deutsche Mark in an orderly, phased-in fashion), the United States could stand to benefit handsomely. Any unraveling of the euro would end that currency’s function as a reserve currency and boost the demand for safe-haven assets in the United States. As a result, a stream of money from Asia and elsewhere would flow into United States Treasury bonds, and thus provide financing for U.S. deficits. Although a stronger dollar would hurt American companies trying to sell abroad, a stronger greenback would also bring benefits to American consumers, in the form of lower oil and commodity prices and lower inflation.

Geopolitical Consequences:

A collapse of the euro would almost certainly spell the end of the EU as we know it. This, in turn, would have broadly positive implications for the United States. The architects of European integration have always dreamed of building a United States of Europe that could act as a counter-balance to America on the global stage. In recent years, European zeal to achieve superpower status has caused endless transatlantic friction on questions ranging from Airbus aircraft to Chiquita bananas to the war in Iraq.

But the euro crisis has already underscored the fundamental weakness of the EU by calling into question the financial viability of its social welfare model [9], which has long been promoted as a primary element of the EU’s soft power alternative to American hard power.

Unfortunately for Europe, the entire European project is hanging by the thread of a highly symbolic but woefully fragile euro. If the euro comes undone, it would rob the EU of its main source of international influence. A post-euro EU would probably devolve from the economic and political union that it is today to a simple free trade zone. In the process, it would deprive Europe of any hope of becoming a viable pole in a future multipolar world. It would also eliminate a would-be geopolitical rival to the United States.

With so much at stake, Europeans are unlikely to abandon the euro without a fight. Nor will Eurocrats, who understand that having a single currency is their best hope of holding and accumulating more power, allow the current crisis to go to waste. Thus it comes as no big surprise that rather than addressing the fundamental root cause of the EU’s current problems, namely profligate spending, Europe’s elite class is now advocating the transfer of yet more political power to an unelected bureaucracy in Brussels.

European leaders are saying that in order for the euro to survive, Europe urgently needs an “economic government [10],” one that would transfer all remaining responsibility for economic decision-making from individual EU nation states to Brussels. Under the scheme, EU countries would forfeit complete sovereignty over national tax and spending policies, all in the interests of “improved coordination.”

Romano Prodi, the former president of the European Commission, once told CNN [11] that the euro was “not economic at all; it is a completely political step. The historical significance of the euro is to construct a bipolar economy in the world. The two poles are the dollar and the euro. This is the political meaning of the single European currency. It is a step beyond which there will be others. The euro is just an antipasto.”

It remains to be seen whether the euro will stand or fall. But either way, Europe seems set to lose.
--------------------------------------------------------------------------------

Article printed from Pajamas Media: http://pajamasmedia.com

URL to article: http://pajamasmedia.com/blog/what-would-a-euro-collapse-mean-for-the-united-states/

URLs in this post:

[1] branding critics as anti-European traitors: http://www.stedwardspress.co.uk/Brussels_laid_bare.html

[2] Merkel recently told: http://www.bundeskanzlerin.de/nn_683580/Content/DE/Artikel/2010/05/2010-bkin-sz.html

[3] German Bundestag: http://www.bundeskanzlerin.de/nn_683580/Content/DE/Artikel/2010/05/2010-05-19-regierungserkl_C3_A4rung-stabilisierung-euro.html

[4] Jean-Claude Trichet: http://www.spiegel.de/international/europe/0,1518,694960,00.html

[5] Silvio Berlusconi: http://www.eubusiness.com/news-eu/greece-finance.4j7

[6] screwed everybody: http://www.independent.co.uk/news/business/news/berlusconi-euro-screwed-everyone-500629.html

[7] Nicolas Sarkozy: http://www.elpais.com/articulo/espana/Zapatero/Sarkozy/amenazo/salirse/euro/elpepiesp/20100514elpepinac_2/Tes

[8] economists were predicting: http://www.imf.org/external/pubs/ft/wp/2006/wp06153.pdf

[9] financial viability of its social welfare model: http://pajamasmedia.com../../../../../blog/european-social-welfare-state-model-running-out-of-time-and-money/

[10] economic government: http://www.eubusiness.com/news-eu/finance-economy.3xx

[11] once told CNN: http://books.google.ca/books?id=hl-LBuoF5RcC&pg=PA439&lpg=PA439&dq=prodi+euro+antipasto&source=bl&ots=88ttQXG202&sig=1E0Ut3HpSmRDla9jTVH1icUZLAY&hl=en&ei=s9z9S5-CBZPINeHFjcgN&sa=X&oi=book_result&ct=result&resnum=4&ved=0CB0Q6AEwAw#v=onepage&q=prodi%20euro%2

 

[Edward Campbell]

Here, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail, is a thoughtful piece by Nouriel Roubini, the fellow who, in 2005, predicted the housing bubble and the chaos that followed:

http://www.theglobeandmail.com/report-on-business/economy/solutions-for-a-crisis-in-its-sovereign-stage/article1588038/

Solutions for a crisis in its sovereign stage
Nouriel Roubini and Arnab Das say the euro zone offers a lesson in how not to respond to a systemic crisis

Nouriel Roubini and Arnab Das

FT.com
Published on Tuesday, Jun. 01, 2010

The largest financial crisis  in history is spreading from private to sovereign entities. At best, Europe’s recovery will suffer and the collapsing euro will subtract from growth in its key trading partners. At worst, a disintegration of the single currency or a wave of disorderly defaults could unhinge the financial system and precipitate a double-dip recession.

How did it come to this? Starting in the 1970s, financial liberalisation and innovation eased credit constraints on the public and private sectors. Households in advanced economies – where real income growth was anaemic – could use debt to spend beyond their means. The process was fed by ever laxer regulation, increasingly frequent and expensive government and International Monetary Fund  bail-outs in response to increasingly frequent and expensive crises, and easy monetary policy from the 1990s. Political support for this democratization of credit and home-ownership compounded the trend after 2000.

The result was a consumption binge in deficit countries and an export surge in surplus countries, with vendor financing courtesy of the latter. Global output and growth, corporate profits, household income and wealth, and public revenue and spending temporarily shot well above equilibrium. Wishful thinking allowed asset prices to reach absurd heights and pushed risk premiums to incredible lows. When the asset and credit bubbles burst, it became clear that the world faced a lower speed limit on growth than we had banked on.

Now, governments everywhere are releveraging to socialize private losses and jump-start private demand. But public debt is ultimately a private burden: governments subsist by taxing private income and wealth, or through the ultimate capital levy of inflation or outright default. Eventually governments must deleverage too, or else public debt will explode, precipitating further, deeper public and private-sector crises.

This is already happening in the front-line of the crisis, eurozone sovereign debt. Greece is first over the edge; Ireland, Portugal and Spain trail close behind. Italy, while not yet illiquid, faces solvency risks. Even France and Germany have rising deficits. UK budget cuts are starting. Eventually Japan and the US will have to cut too.

In the early part of the crisis, governments acted in unison to restore confidence and economic activity. The Group of 20 coalesced after the crash of 2008-09; we all were in the same boat together, sinking fast.

But in 2010, national imperatives reasserted themselves. Co-ordination is now lacking: Germany is banning naked short selling unilaterally and the U.S. is pursuing its own financial sector reform. Surplus countries are unwilling to stimulate consumption, while deficit countries are building unsustainable public debt.

The euro zone offers an object lesson in how not to respond to a systemic crisis. Member states started going it alone when they carved up pan-European banks along national lines in 2008. After much dithering and denial over Greece, leaders orchestrated an overwhelming show of force; a €750-billion bail-out bolstered confidence for one day. But the rules went out of the window. Sovereign rescues are legitimized by an escape clause from the “no bail-out” rule intended for acts of God, not man-made debt. The European Central Bank began buying government bonds days after insisting it would not. Tensions in the Franco-German axis are palpable.

Instead of Balkanized local responses, we need a comprehensive solution to this global problem.

First, the euro zone must get its act together. It must deregulate, liberalize, reform the south and stoke demand in the north to restore dynamism and growth; ease monetary policy to prevent deflation and boost competitiveness; implement sovereign debt restructuring mechanisms to limit moral hazard from bail-outs; and put expansion of the euro zone on ice.

Second, creditors need to take a hit, and debtors adjust. This is a solvency problem, demanding a grand work-out. Greece is the tip of the iceberg; banks in Spain and elsewhere in Europe stand knee-deep in bad debt, while problems persist in US residential and global commercial property.

Third, fiscal sustainability must be restored, with a focus on timetables and scenarios for revenues and spending, ageing-related costs and contingencies for future shocks, rather than on fiscal rules.

Fourth, it is time for radical reform of finance. The majority of proposals on the table are inadequate or irrelevant. Large financial institutions must be unbundled; they are too big, interconnected and complex to manage. Investors and customers can find all the traditional banking, investment banking, hedge fund, mutual fund and insurance services they need in specialised firms. We need to go back to Glass-Steagal on steroids.

Last, the global economy must be rebalanced. Deficit countries need to boost savings and investment; surplus countries to stimulate consumption. The quid pro quo for fiscal and financial reform in deficit countries must be deregulation of product, service and labour markets to boost incomes in surplus countries.

Nouriel Roubini is founder and chairman of Roubini Global Economics. Arnab Das is RGE’s managing director for market research and strategy

The Glass-Steagal Act, referenced in the penultimate paragraph, established the Federal Deposit Insurance Corporation (FDIC) in the United States and introduced banking reforms, some of which were designed to control speculation. Glass-Steagal was repealed in 1999.

I’m not sure that the creditors, especially China, are willing to “take a hit” in order to help restore global solvency but I agree with Roubini that it is their best, long term interests to do so.

 

[a_majoor]

Taking a hit will happen, the only real question is will it be a controlled process or will it happen due to some sort of cascade failure (take your pick, the Euro and EU unravelling; unfunded public service pensions pushing municipalities and State governments in the US into bankruptcy, a prolonged capital strike due to massive State intervention in the US economy, personal debt defaults turning into a tidal wave in Canada, Chinese real estate bubbles popping....)

As military people we have certain habits and skills which support levels of self sufficiency. This means that with proper preparation and maybe with a little coordination we can survive and even prosper in the turmoil to come, so long as we have a stockpile of tools, a "victory garden", a posse of friends, co workers or fellow travelers to pool skills and resources with and (worst case scenario) the means to defend what is ours from the looters.

For me the worst part of this is I grew up in a time of incredible optimism. Man landed on the Moon, Canada celebrated the Centennial and all kinds of things seemed to be possible just over the horizon (remember flying cars and missions to Mars?). Throughout my adult life, things seem to have "shrunken", and what sort of world will be left for my children?

 

[a_majoor]

Proof that the solution does not lie in impoverishing ourselves and our children:

http://freedomnation.blogspot.com/2010/05/cut-spending-without-delay.html

Cut spending without delay

I have heard several politicians and members of the chattering class claim that cutting spending immediately would be disastrous to the economy. This was a constant refrain of Gordon brown during the recent UK elections. Mr. Brown constantly claimed that it would be ‘taking money out of the economy.’ The Cato Institute takes on this assumption by using a historical example:

...the “Depression of 1946″ may be one of the most widely predicted events that never happened in American history. As the war was winding down, leading Keynesian economists of the day argued, as Alvin Hansen did, that “the government cannot just disband the Army, close down munitions factories, stop building ships, and remove all economic controls.” After all, the belief was that the only thing that finally ended the Great Depression of the 1930s was the dramatic increase in government involvement in the economy. In fact, Hansen’s advice went unheeded. Government cancelled war contracts, and its spending fell from $84 billion in 1945 to under $30 billion in 1946. By 1947, the government was paying back its massive wartime debts by running a budget surplus of close to 6 percent of GDP. The military released around 10 million Americans back into civilian life. Most economic controls were lifted, and all were gone less than a year after V-J Day. In short, the economy underwent what the historian Jack Stokes Ballard refers to as the “shock of peace.” From the economy’s perspective, it was the “shock of de-stimulus.”

At present the greatest threats to the economy in every western country are the deficit and the debt. The sooner that these issues are dealt with the better it will be for the long term strength of economic development. There is no convincing argument to delay the cuts that are needed.

Posted by Hugh MacIntyre at 3:15 PM
Labels: Economics, smaller government
1 comments:

Anonymous said...

    look at our GDP that came out today, 6.1% in the last quarter.

    does any sane individual believe that this number is the result of REAL economic growth? it is american stimulus leaching into our country through auto sales and other raw materials, thats all. give it one year and we will be once again screamin the blues, only there will be no escaping the next depression. the american (and european for that matter) cupboard is bare.
    economic collapse is imminent. just remember angela merkels words regarding the greece bailout " we bought ourselves two years." NOT " the problem is fixed now, smoooth sailing ahead" like many keynesians hoped.
    buy gold and a bunker, shes going to get nasty.

    brad maynard
    May 31, 2010 11:59 PM

 

[Edward Campbell]

Here, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail, is a good explanation of what’s wrong with the Euro-American “bank tax,” Obama's latest brain fart:

http://www.theglobeandmail.com/news/world/g8-g20/economy/why-harper-is-taking-his-bank-tax-fight-to-europes-doorstep/article1590224/

Why Harper is taking his bank-tax fight to Europe's doorstep
With the G20 approaching, time is running out for the Prime Minister to sell his maverick opposition to the world

Grant Robertson
Banking Reporter

From Thursday's Globe and Mail, updated on Thursday, Jun. 03, 2010

When Prime Minister Stephen Harper meets in London today with newly minted British Prime Minister David Cameron, there will be sparse time for pleasantries. Mr. Harper has a pressing item to deal with, one that has come to suddenly dominate his government’s foreign-policy agenda of late: stopping the push for a global tax on banks.

With little more than three weeks to go until the G20 summit in Toronto, where a bank tax will be on the agenda, the Harper government knows time is short to marshal opposition to what it believes is a dangerous plan.

The bank tax, an idea first raised last year in response to the debate over how to pay for bailouts of financial institutions that collapse during economic crises, is an idea that has seen Canada break from the pack of G20 nations. Though the idea has significant support in the European Union, Ottawa is trying to convince those in the G20 that a bank tax could do more damage than intended. Members of Mr. Harper’s cabinet have fanned out across the globe to argue that such a tax could lead to bigger problems.

If there is ground to be made for Canada, Mr. Harper will find out this week. Following his meeting with the British PM, he will deliver a similar message to French President Nicolas Sarkozy. Jim Flaherty will meet with G20 finance ministers in South Korea on weekend, where similar conversations will take place.

From those talks, a new vernacular has been created. In short, the bank-tax debate turns on three key issues that could dominate the agenda in Toronto.

1. Orderly failure

When the concept of a bank tax was first raised in G20 circles, the world was reeling from a financial crisis that saw billions of taxpayer dollars poured into propping up financial institutions, most notably in the United States, to keep the contagion from spreading.

Amid pressure from EU countries in the G20, the International Monetary Fund was instructed last year to come up with a suggested plan for a bank tax. Its report described a scenario where financial institutions are taxed to cover the cost of the recent bailouts, and to create a contingency fund against future economic disasters.

That contingency fund would provide for what the European Commission calls “orderly failure.” Rather than a hard crash, banks would have money on hand for a soft landing. But in this case, the banks themselves pick up the tab through the tax on their operations.

But the details are a problem: What exactly would be taxed? Proposals have suggested everything from taxing bank profits to executive compensation and individual transactions, and there is no clear consensus. Canada is concerned that the cost of any sort of tax would flow to the consumer.

Of greater concern, though, is who would administer these funds. Would there be a global organization to handle and disperse the emergency dollars when needed – a sort of financial United Nations? Or do countries preside over their own tax funds?

Already there is a divide over that issue: some governments want bank tax money to go into general revenues, not to be held in a contingency account. “France and the U.K. think this tax should go into the budget, not into a fund,” French Finance Minister Christine Lagarde told reporters in Paris. If this sounds like a sticky issue, it is. Keeping track of where the money goes could be a problem. Should a tax be adopted by the G20, the debate over who holds the keys to the vault is only just beginning.

2. Moral hazard

The global bank tax is often considered an insurance policy against bank bailouts, since banks’ mismanagement of risky investments – particularly those tied to U.S. housing and mortgages – is what sparked the crisis of 2008.

But Canada worries a bank tax will have a reverse effect – making the global financial system weaker by encouraging the banks to take more risks than before. Under the so-called moral-hazard argument, the banks would inherently know there is a pool of money to tap if their investments go awry.

“It penalizes strong performers, it increases moral hazard in the system, and it focuses on remediation of future banking failures rather than the regulatory prevention of future financial problems,” said Kevin Lynch, vice-chair of BMO Financial Group and a former clerk of the Privy Council.

Mexican president Felipe Calderon lent his support to Canada’s argument last week in Toronto putting it another way: “If the global economy builds a fund in order to bail out banks – you can be sure that there will be bailouts in the future,” he said.

3. Embedded contingent capital

Knowing he needs a counter proposal, Mr. Harper is taking a complex idea with him to London and Paris: embedded contingent capital.

It’s not the most eye-catching terminology (“bank tax” made for better headlines in the British election). But this is the Canadian solution. Under the plan, banks would sell debt that could be quickly converted to shares in the event of a crisis, giving the banks emergency capital to bail themselves out. The move would cost the banks, since it would dramatically dilute their share pool, hurting shareholders. But if done right, it could prevent messy insolvencies. This notion has gained traction inside Ottawa, since it puts the cost of a bailout at the feet of the financial institutions without explicitly taxing them.

But here, too, the details are yet to be worked out.

“The embedded capital idea, it’s really at an infant stage in its development,” said Steve Foerster, professor of finance at the Richard Ivey School of Business at the University of Western Ontario. “It’s the notion of issuing debt which – in a time of crisis somehow to be determined by a regulator – would then morph into equity. Which would somehow provide a cushion for a bank that was in trouble.”

There are several reports in the media indicating that Brazil, China and India are “on side,” with Canada, on this issue and one hopes that will be enough to put paid to this Euro-American populist rubbish.

 

[a_majoor]

A further look ahead:

http://american.com/archive/2010/june-2010/athens-on-the-potomac

Athens on the Potomac

By Veronique de Rugy Friday, June 4, 2010

Filed under: Economic Policy, Boardroom, Government & Politics, Numbers, Public Square
Paul Krugman is right: America isn’t Greece. That doesn’t mean we aren’t in worrisome shape. And by one measure, we are in worse shape than Greece.

In a recent New York Times editorial, Paul Krugman wrote, “Everywhere you look there are editorials and commentaries, some posing as objective reporting, asserting that Greece today will be America tomorrow unless we abandon all that nonsense about taking care of those in need. The truth, however, is that America isn’t Greece.”

Krugman’s argument is that while both countries face serious and roughly equal deficits as a percentage of GDP, the United States is not at the same risk of defaulting on its debt as Greece is. First, he writes, markets treat both countries differently, as evidenced by the difference in interest rates on Greek government and U.S. government bonds. That’s because Greece is seen as a much riskier investment than the United States.

It is also true that there is no firm rule on when deficits or public debts are too high relative to an economy’s size. Prior to the crisis, the general consensus was that rich countries could safely have public debts worth 60 percent of GDP. And although Japan’s debt has exceeded 100 percent of GDP for many years, the government has yet to suffer a financing crisis.

However, it doesn’t mean that things won’t change. Investors judge default risks on a curve. They will assess one government against others (for instance, the United States vs. France, Germany, China, and Norway). When the markets do lose confidence in a government’s fiscal rectitude relative to others, a crisis can arise quite quickly, forcing countries into painful political decisions. And this could very well happen to the United States.

A recent International Monetary Fund study’s main finding is that the United States might not look better than most other governments forever, and that the hill the United States has to climb to fiscal stability is much steeper than most other countries.

First, under the Obama administration’s current fiscal plans, the gross national debt in the United States will climb above 100 percent of GDP by 2015.

What’s more, the chart above shows that when taking into account entitlement and all other obligations, America’s structural deficit as a percentage of our GDP is far bigger than almost any other country’s (more on this here); it is, in fact, worse than Greece’s.

And don’t forget, the United States has a far shorter maturity of government debt than most other countries, meaning that even if it weren’t borrowing extra cash it would have to issue a large chunk of new stuff over very short periods of time. In other words, the United States is like an addict always looking for his next fix.

This large financial need means that our country is spectacularly vulnerable—probably more than others—if the market suddenly decides it doesn’t want U.S. debt. When that happens, we might be no better situated than Greece.

Veronique de Rugy is a senior research fellow at The Mercatus Center at George Mason University.
FURTHER READING: De Rugy has uncovered many alarming trends in federal debt over past months, including “In-the-Red State,” “America’s Precarious Net Position,” “Mediscare: Our Government-Administered Insurance Looks into the Abyss,” and “What Unsustainable Looks Like.” AEI’s Newt Gingrich discusses a “Mandate for a Balanced Budget,” Desmond Lachman explores “The Greek Economic Crisis and the U.S. Economy,” and Kevin Hassett says “Greece’s Bailout Heroes Arrive in Leaking Boats.”

Image by Rob Green/Bergman Group.

 

[Edward Campbell]

It appears, according to this report, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail, that the “rest” of the G20 (including Australia, Brazil, China and so on) have sided with Canada and have put paid to that bit of American and European populist political rubbish, the bank tax:

http://www.theglobeandmail.com/news/world/g8-g20/economy/canada-wins-key-fight-against-bank-tax/article1593382/

Canada wins key fight against bank tax
G20 finance ministers approve a plan that allows countries to manage the issue as they see fit.

Bill Curry

Busan, South Korea — Globe and Mail Update

Published on Saturday, Jun. 05, 2010

Canada has won a key fight in its high-profile international campaign against a global bank tax as G20 finance ministers Saturday approved a plan that allows countries to manage the issue as they see fit.

Proponents of such a tax _ including the United States and Europe _ are free to go it alone, but the new plan allows the rest of the G20 to avoid the controversial idea and find other ways to reduce banking risks.

“The majority of the countries in the G20 do not support an ex ante bank tax, that is clear,” Canadian Finance Minister Jim Flaherty said at a news conference following a two-day meeting of G20 finance ministers and central bankers.

“At the end of the day, different countries will chose different ways of reaching the goal [that banks should pay for government interventions] but there is no agreement to proceed with an ex ante bank tax,” he said.

In their final communiqué, G20 finance ministers and central bankers said the financial sector must make a “fair and substantial” contribution to paying for any of the burdens associated with government intervention.

However, the statement then goes on to include wording that will allow most G20 members to avoid a bank tax, should they choose. For instance, the requirement for banks to pay back government aid is limited to those countries that actually bailed out their banks. There is also wording allowing countries to choose from a “range” of policy options in this area that take into account their own individual circumstances.

Europe and the United States are the main proponents of a bank tax _ partly to recoup taxpayers’ money used to bail out banks during the recession. But the European Union and the United States have also argued that it is in the interests of all G20 countries to create a fund via a global bank tax so that governments aren’t on the hook again to cover the huge costs of protecting vulnerable banks in a downturn.

Japan’s Deputy Finance Minister Naoki Minezaki and Australian Finance Minister Wayne Swann also spoke out publicly against the tax here this weekend. The G20 leaders will receive a second International Monetary Fund report on the proposal when they meet in Toronto, but it is clear there will be no broad agreement for joint action on a bank levy.

The decision to make the bank tax voluntary for G20 members is essentially what Canada, through Mr. Flaherty and Prime Minister Stephen Harper, have argued in recent weeks as the two men blitzed key the world for face-to-face meetings with key G20 members including the E.U., China and India.

On the complex issue of banking reforms _ including a common definition for high-quality capital and the percentage of capital banks should have on hand _ the G20 has agreed that a plan will be announced in November when leaders meet in Seoul.

Banks generally resist higher capital requirements because it cuts into profits. But many G20 leaders say sorting out this issue is the most important way governments can prevent the kind of risky practices that were at the root of the financial meltdown.

Agreement is proving a challenge however because the United States, Europe and Asia currently have dramatically different rules on what qualifies as Tier 1 capital and how banks can leverage money.

U.S. Treasury Secretary Timothy Geithner said the G20 is focused on a finding agreement in time for the November meeting of G20 leaders in Seoul in November.

“The United States is moving aggressively to fix the things we got wrong and to strengthen our economic fundamentals and we will give our full support to the G20 agenda of growth and reform. ”— U.S. Treasury Secretary Timothy Geithner

Mr. Geithner also warned that the G20 should not count on American consumers to fuel an economic recovery.

“Within the G20, we discussed how the ongoing shift toward higher savings in the United States needs to be complimented by stronger domestic demand growth in Japan, in the European surplus countries and by sustained growth in private demand, together with a more flexible exchange rate policy in China,” he said.

The G20 includes the G7 countries of Canada, France, Germany, Italy, Japan, the United Kingdom and the United States as well as Argentina, Australia, Brazil, China, India, Indonesia, South Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey and the European Union.

Of course the Americans and Europeans can still punish the survivors of the financial crisis and, thereby, appease the economically illiterate majorities in their populations. Bank taxes are popular and stupid; people want them so the American and European governments will give in. Obama may actually believe in what he’s doing.

 

[Brad Sallows]

I can only hope the "bank tax" is dead.  It is an insurance scheme which just happens to propose payments based on some formula tied to revenue rather than an actuarial calculation.  I am not impressed by an invitation to share the costs of insurance we do not need, from those  those who would draw on the insurance pool.

 

[Edward Campbell]

Here, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail, is an interesting comment on the interactions at the forthcoming G8/G20 meetings:

http://www.theglobeandmail.com/news/world/g8-g20/economy/what-china-wants-from-the-g20/article1595426/?cmpid=rss1

What China wants from the G20
Aside from greater influence within the IMF and World Bank, Beijing isn’t saying much

Mark MacKinnon
Beijing — Globe and Mail

Published on Monday, Jun. 07, 2010

It’s a question that hangs heavily over the world’s leaders as they prepare to gather in Toronto at month’s end for the Group of 20 summit. What does China, the world’s fast-emerging “other” superpower, want from the gathering?

Canada and other countries have laid out detailed bargaining positions on pivotal issues such as when to end stimulus spending by governments and whether to levy an international tax on banks. But Beijing has said little, even as others have made demands of China, such as repeated calls to release its currency, the yuan, from an artificially low peg to the U.S. dollar.

Still, Beijing is indeed coming to Toronto with its own agenda, highlighted by its demand that the world’s financial superstructure – particularly the World Bank and International Monetary Fund – be reformed to reflect Beijing’s new economic might.

“The issue of international financial institutions has been raised here with me, as I expected it would,” Mr. Flaherty said after two days of meetings with Chinese officials during which he lobbied hard for Beijing to back Canada in its opposition to a U.S. and European proposal for an international tax on banks.

Mr. Flaherty hinted that China in turn was looking for support on its own pet issue. “Canada has supported reform of international financial institutions to better reflect the emerging economies in the world, and we’ve done that at the World Bank, and we’ve done that at the IMF. Canada will continue to support those kinds of reforms,” he said.

China already secured agreement in principle on the idea of IMF reform at the Washington meeting of G20 finance ministers in April, though there is no detail yet on the proportion of the voting shares to be transferred. China – the world’s third-largest and fastest-growing economy – currently has the sixth-most votes, a 3.7-per-cent share.

The United States, which hosted the meetings that gave birth to the IMF and World Bank at Bretton Woods, N.H., in 1944, has by far the largest block, with slightly more than 17 per cent of the vote – nearly three times the proportion given to the world’s second-largest economy, Japan.

The issue of IMF and World Bank reform is fraught with political baggage. The post-1945 order established at Bretton Woods is often referred to as the Washington Consensus, led by the country that emerged strongest from the Second World War. Some now believe a “Beijing consensus” is emerging, or at least a new international order where China and the United States effectively constitute a “G2.”

Xu Mingqi, deputy director of the Shanghai-based World Economics and Politics Institute of the Chinese Academy of Social Sciences, said that China has been the third-largest economic entity in the world for some time now and this year will overtake Japan to become second largest. “China’s role is objectively enhanced in the world economy,” he said.

“In all of the issues related to the international economic orders – no matter whether China will or will not receive the vote shares [at the World Bank and IMF] – China’s voice will be stronger than before,” Mr. Xu said.

China wants to see the promises of reform turned into action soon, he added.

“It is certainly important to China. IMF reform is about strengthening the right to speak of developing countries, and about further maintaining the international financial market’s stability, and to avoid the financial crisis from becoming worse again. This is also what China needs.”

Beyond the demand for a bigger say in the global financial system, experts say China is otherwise in a watch-and-wait mode when it comes to the G20. Beijing remains uncertain whether the G20 is a forum that can advance its interests, or another body that will follow Washington’s lead – and that could potentially single China out for criticism of its currency manipulation and other policies.

“Who are the leading voices [in the G20]? What are the potential alliances, friendships and demarcation lines on the issues? This is still being debated in China,” said Wenran Jiang, a China expert at University of Alberta. Despite claims from Canadian officials that Beijing was on their side in the debate over the bank tax, Mr. Jiang described China’s position on that and other key issues facing the Toronto summit as “murky.”

“China is going into the summit without pre-exposing itself on most of its positions. Rather than taking the lead or calling the shots, they’re observing.” The only exception, Mr. Jiang said, was IMF and World Bank reform, which he called “a line-in-the-sand issue that they won’t back down on.”

______

What Canada wants from China

Finance Minister Jim Flaherty’s message to Beijing is that Canada welcomes China’s larger role on the world stage, but that the world needs China to look beyond its national interests when setting its economic policy.

Speaking last Thursday to a room of potential investors in Beijing, he praised China’s “increasingly influential” role on the international scene, but suggested the sustainability of the global economic recovery might well depend on China adjusting its currency – which economists say has been kept low to give Chinese exporters a competitive edge – and convincing its own citizens to spend more and save less.

“Success is only possible if everyone follows the same rules. Where imbalances exist, in emerging and advanced countries alike, we must fix them,” Mr. Flaherty said. “If we are to sustain the global recovery, other nations will need to reduce their savings, and combine this with structural reforms and exchange rate adjustments.”

He also added that it was time for all governments, including Canada’s and China’s, to start withdrawing stimulus money from their economies. China’s massive $586-billion (U.S.) stimulus package is widely credited with helping the country to avoid the recession that hit many of its main export markets, and Beijing has indicated it wants to keep the policy in place as long as there is uncertainty on the global markets.

It’s a refrain Chinese leaders have been hearing since the onset of the global economic crisis in 2008, when they first moved to repeg the yuan, which was briefly allowed to float on the market between 2005 and 2008, at about 6.8 to the U.S. dollar. But outside pressure from the likes of U.S. President Barack Obama has yielded nothing from China but a vague promise to gradually let the yuan, also known as the renminbi, appreciate, starting at a time of Beijing’s choosing.

The value of the yuan is sure to be raised again in Toronto. But China is expected to make clear that the old order – which included the United States and other powers talking down to it through institutions such as the IMF and World Bank – no longer works.

A draft communiqué circulated ahead of last weekend’s meeting of Group of 20 finance ministers in South Korea indicated that China will get its way on the issue that matters most to them. It urged “concrete progress” on reforming voting quotas at the IMF ahead of the leaders’ summit in Toronto. It made no mention of China’s currency.

Mark MacKinnon

As a start: this is probably the last G8 meeting that has any meaning at all. A Gn without China is worthless – a forum of America, Europe, Japan, Russia – Russia for heaven’s sake – and Canada has nothing much to say to anyone.

There is an emerging G2: America and China which might become a G4 America + China + Europe (one ‘seat,’ one ‘voice,’ one ‘vote’ – very tough for the Europeans to manage) and India. Canada needs to try to steer that towards ASEAN + China + EU + India + MERCOSUR + NAFTA (multiple 'seats' (if desired) but only one 'voice' or 'vote' each) so that we can retain some influence. Meanwhile the G20, in which Canada, China and India have seats and votes,  is rapidly emerging as the key forum – despite being too large and filled with too many failing economies.

 

[Edward Campbell]

According to this report, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail, American legislators remain laughably hypocritical:

http://www.theglobeandmail.com/report-on-business/economy/chinese-trade-numbers-fuel-angry-us-response/article1599957/

Chinese trade numbers fuel angry U.S. response
Lawmakers demand to know what Obama administration will do to address widening imbalance

Brian Milner

Globe and Mail Update
Published on Friday, Jun. 11, 2010

China’s powerful export machine is back in overdrive, adding fuel to one of the world’s great trade battles as pressure mounts on Beijing to raise the value of its currency.

The latest trade numbers from China , much stronger than analysts had anticipated, are turning up heat on the Obama administration to curb what has been widely viewed as an unfair Chinese trade advantage stemming from its deliberately undervalued yuan and hefty subsidies to the export sector.

Even before the latest data, U.S. lawmakers had joined in rare bipartisan agreement to press for a tougher stance on China, as Beijing continued to rebuff international calls  for a currency revaluation. Thursday, exasperated senators, facing growing anger from constituents over high unemployment and a sluggish recovery, demanded to know what the administration is going to do to address the widening imbalance.
China reported that exports soared 48.5 per cent in May from a year earlier. Not even a surge in imports could keep the country’s trade surplus from ballooning to $19.5-billion (U.S.) from $1.7-billion in April and a deficit in March. The surplus on trade with the U.S. widened in April to $19.3-billion from $16.9-billion, and the shortfall is expected to grow in the months ahead, as a slowly reviving U.S. economy sucks in more imports.

“The distortions caused by China’s exchange rate spread far beyond China’s borders and are an impediment to the global rebalancing we need,” U.S. Treasury Secretary Timothy Geithner told the Senate finance committee Thursday. A “more flexible” currency “will allow market forces to play a more active role over time in facilitating strong, balanced and sustainable growth globally,” he said.

The fresh reading brought renewed calls in the United States to force Beijing’s hand.

“I'm not sure what this administration’s policy is,” fumed Montana Democrat Max Baucus, head of the finance committee and a long-time protectionist.

Another trade hawk, New York Democrat Charles Schumer, told Mr. Geithner that lawmakers will push ahead with legislation to impose countervailing duties and other penalties on the goods of any trading partner whose currency is found to be “fundamentally misaligned” with the U.S. dollar.

“There’s no doubt that there’s a lot of pent-up frustration with China in the United States,” said Marc Busch, a professor of trade policy and law at Georgetown University in Washington. “The politics are largely outstripping any economic reality in this discussion.”

The Chinese allowed the yuan to appreciate by 22.5 per cent against the dollar between 2006 and mid-2008, but then froze it at a level slightly above 6.8 yuan to the greenback in response to the global crisis. It has stayed there ever since, while its implicit value has climbed steadily, thanks to economic gains.

“The trade deficit with China is reducing U.S. GDP by more than $400-billion or nearly 3 per cent,” said Peter Morici, a business professor at the University of Maryland and former chief economist with the U.S. International Trade Commission. “Unemployment would be falling rapidly and the U.S. economy recovering more rapidly but for the trade deficit with China and Beijing’s currency policies.”

China has argued repeatedly that revaluing the currency would not affect the trade imbalance with the United States, and said changes to policy will be made at its own pace, not that of other countries. And it is by no means clear that a revalued yuan would dampen imports from China or even cause prices to rise.

“How much of the Chinese value chain is priced in Chinese currency?” Prof. Busch asked. “Much of it is denominated in U.S. dollars, so would a revaluation accomplish anything?”

Numbers being bandied about in Washington and other finance circles indicate that an appreciation of 5 to 8 per cent might be enough to mollify China’s Western trading partners. But that would likely have no impact, he said. “What revaluation are we waiting for that’s going to undo the trade imbalance?”

In any case, the anti-Chinese lobby is ignoring a crucial piece of information, namely that Chinese imports are also surging, some China trade watchers say.

“The big news on the trade front for China is the soaring import numbers,” said Ken Courtis, founding partner of Themes Investment Management in Hong Kong.

Japan, South Korea, Taiwan, Australia and several other Asian countries are running hefty surpluses with China. Germany is headed for a positive trade balance by the end of the year, and China has emerged as the fastest-growing market for U.S. exports.

First: China should float its currency, despite the near term, but temporary, economic hardship that will create for its own people. My guess is that internal social harmony is much, much more important to the Chinese leadership than is all the huffing and puffing the USA can manage.

Second: the US is debasing its own currency in a conscious effort to emulate the Chinese by artificially lowering the price of their exports and, concurrently, making imports more expensive. That’s why people like Baucus, Geithner and Schumer are hypocrites. Oh, and intentionally debasing one’s own currency is economic stupidity – congratulations, Mr. President, on shooting yourself (and your country) in the foot.

 

[Kirkhill]

Max Baucus is an annoying, arrogant, pig-headed b*st*rd.  He is the face of Softwood Lumber and Montana.

He is also a great Senator that constantly gets re-elected because he does what he is paid to do: protect the interests of those that elected him. He fights bare-knuckled in a bare-knuckled world and really doesn't care if that makes him appear hypocritical to the rest of the world - including his own party.  Check that comment about "his" administration. 

“I'm not sure what this administration’s policy is,”

.  In that he is not alone.....

I detest hypocrisy as much, or more, than the next man.  It makes it harder to plan.  But personal morality doesn't translate well into the corporate sphere and sure doesn't have much of a following in those corporations we know as the nation-state.

Besides, one man's hypocrisy is another's following the democratically expressed desire for a different policy.

I'd sooner Max Baucus as President than the pusillanimous, vacuous non-entity that is currently in office.  I may not like the policies that proceed from his values but he has  values and I can understand them and thus make useful predictions about what he will do.

Surprise is only useful militarily.  In virtually all other fields I value predictability.

 

[Edward Campbell]

This, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail, illustrates that, indeed, China is “no longer just a low-wage workshop:”

http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/a-breakthrough-in-china-another-blow-for-sudbury/article1601530/

A breakthrough in China, another blow for Sudbury
No longer just a low-wage workshop, China is reshaping world markets through innovation - including a revolutionary alloy that takes aim at Canada’s nickel belt

Andy Hoffman Asia-Pacific Reporter,

Xuzhou, China — Globe and Mail Update
Published on Friday, Jun. 11, 2010

Ask Li Guang about the prospects for his business and a self-assured grin creeps across the young executive’s face. It’s a smile that means trouble for Canada’s nickel-mining capital of Sudbury, Ont., more than 11,000 kilometres away from Mr. Li’s office in eastern China .

“Our production has quite a lot of advantages compared to refined nickel,” says the budding metals titan, who is all of 30 years old and dressed in a short-sleeve dress shirt and black jeans. “Now, in China, many other enterprises are going to enter this market. Gradually they will take over a lot of the share of refined nickel.”

Mr. Li and his company, Jiangsu Mingzhu, are among the many Chinese manufacturers churning out a revolutionary product known as nickel pig iron or NPI. Despite its prosaic name, the alloy has set the global nickel industry on its ear by providing a low-cost alternative to the refined nickel that has typically been used to make stainless steel. Cheap NPI threatens to squelch demand for the refined metal, which is produced in places like Sudbury, as well as in Russia and Australia.

In less than five years, NPI has reshaped the world nickel industry, marking a new stage in China’s capitalist evolution. Since it opened itself to trade in the late 1970s, the Asian nation has become famous for two things – lowering the price of manufactured products with its cheap labour costs, and driving up the price of commodities with its aggressive demand. Now it is altering the fundamentals of a vital industrial sector with a homespun innovation.

NPI, a material produced in low-tech Chinese factories, already accounts for as much as 10 per cent of the world’s $21-billion-a-year nickel market, more than all the nickel that can be produced annually in Sudbury. Some analysts expect China’s NPI producers to double their output this year.

The booming supply of the new product hits hard at traditional nickel miners. Until recently, the world’s largest mining firms believed that surging Chinese demand for the metal would last for decades. As a result, fevered takeover battles erupted in 2006 and 2007 for Canada’s two nickel giants, Inco and Falconbridge.

But the days of $24 (U.S.) a pound nickel, last witnessed in 2007, are unlikely to ever return. The average Chinese producer of NPI can now be profitable at nickel prices of about $8.50 a pound – just about exactly where prices stand right now. If nickel prices were to surge, China’s NPI producers could quickly flood the market with their lower-cost alternative.

“It does put a cap on world nickel prices. If not in practical terms, at least in psychological terms,” concedes David Constable, vice-president of investor relations at Quadra FNX Mining Ltd., a Canadian company that began as a Sudbury nickel producer but has diversified its production to focus primarily on copper.

BHP Billiton Ltd ., the world’s largest mining firm, has already turned bearish on nickel and sold some of its mines. The emergence of NPI was a key factor in the decision, analysts say. They expect the Chinese product’s impact to only get larger with time, as more producers enter the fray.

In a worst-case scenario, NPI could usurp all of China’s demand for traditional nickel, reducing the global market for the metal and creating a nightmare for firms that paid top dollar for nickel assets at the height of the market. Among the firms that invested heavily were Vale SA, the Brazilian iron ore giant that paid $19.4-billion in 2006 to win control of Inco’s Sudbury operations, and Xstrata PLC, the Anglo-Swiss metals conglomerate that scooped up Falconbridge and its Sudbury nickel assets at a price that valued the company at more than $22-billion. (Both Vale and Xstrata declined comment for this story.) Vale’s nickel production in Sudbury and Voisey’s Bay, Newfoundland, has been crippled for nearly a year by a bitter strike over workers’ wages and benefits. If and when production resumes, the company’s commitment to exploration and expansion in Canada will have to be made with the threat of NPI looming large.

How did a low-profile collection of Chinese manufacturers upset the plans of the world’s mining giants? It’s a story about ingenuity born out of necessity. It’s also a story about China’s emerging entrepreneurial class and its growing impact on the global economy.

Cost advantage

The heart of Mr. Li’s burgeoning metals empire is hardly a high-tech showpiece. The plant where Jiangsu Mingzhu produces NPI in the city of Huaibei in China’s Anhui province belches smoke. A stray dog picks at a pile of rubbish, while a worker sits atop a hill of nickel ore, spraying it down with a hose to keep it from turning to dust and blowing away in the wind.

The NPI plant sits right beside its electricity source – a coal-fired plant. “We spend 160,000 yuan [about $24,300 Canadian] on electricity per day,” boasts Wu Jinduo, the plant’s sales and supply director.

Workers begin the NPI process by mixing together three ingredients – coking coal, nickel ore from Indonesia, and a mix of gravel and sand known as aggregate or flux. The mix goes into one of the factory’s three furnaces, where it’s blasted with high heat, reduced and concentrated. The molten material is then poured into moulds to make bars of nickel pig iron. Workers use long metal rakes to scrape the remnants of the metal liquid from the container.

The process is dirty, dangerous and rudimentary. But it contains some vital advantages.

Foremost among those advantages is the factory’s ability to capitalize on several low-cost materials – cheap power, a small amount of coking coal, and, most important, low-grade Indonesian ore.

The ore contains less than 2 per cent nickel, making it unsuitable for traditional nickel production. But it is nearly half iron. Thanks to that high iron content, the NPI that emerges from this plant contains a generous amount of nickel – 10 to 12 per cent – mixed into a base that is nearly all iron.

For China’s thousands of stainless steel producers, the combination of nickel and iron is hugely attractive. They pay NPI producers the same price (or slightly less) as they would pay traditional producers to get the nickel content they need to make stainless steel. They get a bonus of iron – another ingredient needed to make steel – for free.

Exactly who invented the NPI process is unknown. Industry executives say Chinese producers took their first faltering steps with the product around 2005. The early batches of NPI were prohibitively expensive and low grade, containing only about 4 per cent nickel or less. The world’s big nickel producers took little note.

Development went into fast forward when nickel prices spiked in 2007 and China’s stainless steel producers were forced to look for alternatives. As nickel soared to $24 (U.S.) a pound from $10, the economics of NPI suddenly looked more attractive. Many Chinese smelters along the country’s east coast switched from producing other metals to making NPI, a shift that led to major improvements in smelting techniques.

In Xuzhou, Mr. Li’s company was among the most important innovators. Mr. Li’s father had founded Jiangsu in the 1980s to produce metal alloys, but by 2006, the company had moved into producing NPI. It soon figured out a way to enhance the quality of the material. “We were the first enterprise in China to smelt pig iron by electric furnace,” Mr. Li says.

By switching from blast furnaces to electric furnaces, Chinese NPI producers can now make material containing between 8 and 15 per cent nickel. Similar in quality to ferronickel produced by nickel giants such as Vale, the Chinese NPI production can be used to make high-end “300 Series” stainless steel.

By 2009, the top NPI producers had reduced production costs to between $7 and $8 a pound, according to analysts. By December of last year, approximately 70 Chinese firms were producing NPI, says Celia Wang, an analyst at Shanghai Metals Market, a unit of research firm CBI China, and an expert in the NPI industry.

Ms. Wang estimates that NPI production hit 44,000 tonnes of nickel in the first quarter and she expects output to break records this year, reaching between 160,000 tonnes and 180,000 tonnes of nickel – production that otherwise would have come from traditional refined nickel miners.

China is expected to gobble even more NPI in the future. Until now, demand has been driven by small private manufacturers of stainless steel. The country’s largest steel producers, the state-owned enterprises (SOEs), have yet to begin using NPI on a wide scale.

Mr. Li says it’s only a matter of time before the big producers, which make about 40 per cent of China’s stainless steel, turn to NPI. “They sell their products in the higher end of the market so they can afford refined nickel, right now,” he says during an interview in his spacious office in Xuzhou. He predicts that within two years the SOEs will diversity their sources of supply. If so, that will take another big bite out of global demand for refined nickel.

A metal gets hammered
Graphic by the Globe and Mail

Environmental worries

The question is whether NPI will become more than a Chinese phenomenon. Because of steep duties, it’s not economical for Chinese NPI producers to export their product to stainless steel producers outside of China. However, Jiangsu Mingzhu is planning to build an NPI plant in the Philippines; it is also looking at constructing another offshore plant in Indonesia.

Jim Lennon, an analyst with Macquarie Group based in London, isn’t ready to write off the traditional nickel industry just yet. He points out that NPI requires not only cheap nickel ore, but also coking coal and inexpensive electricity – a combination that is hard to find outside of China. Still, Mr. Lennon expects that NPI production in China could reach 200,000 tonnes of nickel this year, or about a third of Chinese demand.

What could stop China’s NPI boom? One threat is growing environmental concerns. China has already moved to shut scores of high-polluting coal plants and could set its sights on smelters used to produce NPI. As well, if China allows its currency to appreciate, NPI producers could feel the pinch.

But Mr. Li, the young chief of Jiangsui Mingzhu, doesn’t seem to be worried. With five plants in China, Jiangsu is now the country’s second-largest NPI producer. Mr. Li plans to take his company public on the Hong Kong Stock Exchange within the next two years. He has plenty of reason to grin – and Sudbury has plenty of reason to worry.

______

Everything you ever wanted to know about nickel pig iron but were afraid to ask

What is it?

Nickel pig iron (NPI) is a material produced in China that is used as a substitute for traditional refined nickel in the production of stainless steel. Nickel is the key ingredient that makes stainless steel shiny and corrosion resistant.

Is it new?

Yes. NPI was first made in China in 2005 and only produced in large quantities beginning in 2007.

How is it made?

The key ingredient in NPI is low-grade ore, usually imported from Indonesia or the Philippines. The ore, which generally contains less than 2 per cent nickel, is unsuitable for traditional nickel production. NPI manufacturers mix the ore with coking coal and aggregate or gravel, then transfer it to a furnace, which smelts it. NPI producers originally used blast furnaces powered by coal, but a new generation of producers rely upon electric furnaces, which produce NPI with a higher nickel content.

What does NPI consist of?

NPI consists of 4 to 15 per cent nickel. The rest of the material is pig iron – an important advantage since iron is also needed to produce stainless steel.

How is this different from traditional nickel from Sudbury?

Traditional nickel begins with higher-grade ore, with a nickel content typically above 2 per cent. The ore is crushed and smelted to remove many impurities. The smelted material goes to a refinery where it is processed into pure nickel.

Is NPI cheaper to produce than refined nickel?

It depends upon how you do your accounting. Innovation and improved technologies have reduced the cost to between $7 (U.S.) and $8 a pound of nickel. In comparison, the cost of producing a nickel in Sudbury is thought to be about $5 a pound. However, the cost of building a traditional nickel mine, smelter and refinery are massive compared to the cost of building an NPI factory.

Why do Chinese stainless steel producers use NPI?

For two reasons. One, they can often buy the nickel content in NPI for slightly less than buying the equivalent amount of pure nickel. Two, they get the pig iron in NPI – which they need to produce stainless steel anyway – for free.

Why is NPI used only by Chinese stainless steel producers?

China levies a steep export duty on NPI that makes it cost prohibitive to ship the product outside of the country. To avoid the duty, some Chinese companies are planning to build NPI plants in the Philippines or Indonesia.

Andy Hoffman

Don’t read too much into this. With 1.3(+) Billion people the Chinese are, now and again, bound to be creative and entrepreneurial and to get things ‘right.’ China still has many, many problems and its “rise” to global great power status, while almost certainly inevitable, will not be perfectly smooth.

But it does point out the importance of innovation, something that, over and over again, is found to be lacking in Canada.

 

[Edward Campbell]

I like the headline on this article, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail, as a counterpoint to the article just above about China’s new nickel industry:

http://www.theglobeandmail.com/globe-investor/markets/markets-blog/nickels-nice-but-oil-is-the-china-card/article1601438/

Nickel’s nice but oil is the China card

David Berman

Friday, June 11, 2010 7:41 PM

The Chinese economy is developing at a blistering pace, and the country is acquiring a talent for producing things it once needed to import. From cars to telecommunications equipment to steel products, China has arrived on the world stage.

However, its a safe bet that China is always going to need imported oil, and lots of it.

China is already the world’s second-largest oil consumer, behind the United States, and its thirst appears unquenchable. According to the Institute for the Analysis of Global Security, China’s oil consumption is growing by 7.5 per cent a year, which is seven times faster than U.S. growth.

This wouldn’t be a huge problem if China were a great oil producer. It isn’t. Its reserves are puny next to its needs, a fact made clear when it switched in 1993 to being a net importer of oil from a net exporter. These days, China produces about four million barrels of oil a day, but burns through about 7.6 million barrels a day.

With rising demand, the days of cheap oil are over, which is good news for oil companies and energy investors. Even better news is the fact that China has shown a strong desire to own oil-producing assets, and pay handsomely for them.

Through its state-owned investment and energy companies, China has already bought stakes in Athabasca Oil Sands Corp., Syncrude Canada Ltd. and Penn West Energy Trust – in deals that total more than $8-billion.

The Chinese aren’t likely finished their shopping spree: PetroChina Co. alone plans to spend $60-billion (U.S.) on international acquisitions over the next decade, according to the company’s chairman.

Some of that money will come to Canada, no doubt, and wise investors will be ready for it.

Message to President Obama: there is no suck thing as “dirty oil;” if the USA doesn’t want our heavy oil the Chinese will buy all we can produce. I’m not sure that we shouldn’t be using oil as a lever to ‘soften’ the border – the Americans (Homeland Security and the Congress) are being stupid and, probably, dishonest, in their efforts to ‘protect’ the USA by ‘thickening’ their Northern border. They can, of course, do as they please with their border but so can we, with the NAFTA. The NAFTA guarantees the USA fair access to Canadian oil; if we withdraw from NAFTA, as Obama threatened to do during the 2009 campaign, that guarantee is nul and void and we can sell as much, or as little of our oil as we please, to anyone who will pay.

But, just selling resources does not do much for our real productivity problems - that's where the Americans and the Chinese are kicking our asses: innovation. They do it, we don't. Our corporate culture and our political culture are both incredibly 'conservative' - content to hew the wood and draw the water and to let others figure out how to process it and add value.