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Friday’s Top 10

Published in Interest.co.nz (Auckland), 11 April 2014

1. If only we had saved, we might be rich (or not)

The Financial Services Council released a new study this week claiming that New Zealand could be $278 billion better off today had it not dropped its compulsory savings scheme in 1975 (which had only been set up a year earlier).

Calculating the contributions that were never made and adding them up over the years led to this startling figure.

But not everybody is convinced it is that easy to assess what would have resulted from the scheme.

Michael Littlewood of the Retirement Policy and Research Centre at Auckland University explains why the logical behind the Financial Services Council study is flawed:

Michael Littlewood, said the figures were calculated in a vacuum that assumed contributions made by employees did not change people’s behaviour and assumed a positive rate of return. “You only need to look at Australia to see how a scheme like this changes behaviour.” Mr Littlewood said that in Australia people tended to retire earlier. But they retired with more debt because they incurred it knowing they would be able to access that savings pool to pay it off in the future. “There are a whole bunch of distortions.”

It was also a big assumption to say that the amount of money would be good for New Zealand’s capital markets. There was no evidence of a capital shortage and putting extra money into the sharemarket might have resulted only in prices going up. “The calculations are totally notional.” Mr Littlewood said more savings did not necessarily generate more growth. “You just need to look at Japan. They have oodles of savings but have had negative growth for years.”

2. Markets at their best
This week, American airlines demonstrate how markets respond to changing scarcity levels.

Due to unrest caused by drug cartels and flooding from heavy rains in Mexico and a drought in California, the price of limes had skyrocketed.

Passengers would not need to know about these background developments but they might notice that there is something else in their drinks.

A wonderful example of how decentralised decision-making in markets adjusts to changing circumstances without the need for a Lime Distribution Authority:

“We still serve limes, though they’re more difficult to source. So, on some flights we’re substituting with lemons,” says spokesman Rahsaan Johnson. For frequent fliers like Ben Schlappig, author of the travel blog One Mile at a Time, that won’t cut it. “There are lots of cocktails where lemon simply isn’t a substitute for lime,” he says. One of United’s largest caters told the airline that it has 15 to 20 percent of the typical lime inventory. The airline expects to have a normal supply of limes by late May.

3. Fuel reductions from the granny cloud
And yet another example of how in an interconnected world everything depends on everything else.

Who would have thought that Skyping your granny would leave a dent in the demand for petrol?

Well, Z Energy chief executive Mike Bennetts has found a clear effect of broadband availability on his business.

“People are doing less discretionary motoring and that may be about the price but what we have found is quite a strong link between broadband connexions and fuel consumption,” he said. “People are doing online shopping and Skyping granny rather than making the fortnightly visit.”

A 1 per cent improvement in broadband connectivity is estimated to cause a drop of 200 million litres a year in national fuel demand, more than the impact of GDP growth, population, fleet turnover, vehicle efficiency and the petrol price.

4. Greece is back – or is it?
Greece is preparing for a return to capital markets. In a few days time, the crisis prone country plans to issue a government bond for the first time in years. It seems safe to do so, given that Greece’s yields have fallen back to (almost) pre-crisis levels.

There is only one small catch: The new optimism about Athens is fuelled entirely by an expectation that other European countries will continue to bail out Greece if necessary. (The Greek bond auction overnight was eight times over subscribed and had an average yield of 4.95%).

Fiscal and economic figures today are actually worse than at the beginning of the crisis. The Financial Times ends on a note of caution:

While it was “natural” for Greece to test the market, the country should be wary of paying too high a price, Klaus Regling, head of the European Stability Mechanism rescue fund, warned in a Greek newspaper at the weekend.

Despite the potentially attractive yields, many longer-term investors remain cautious given the country’s perilous public finances: Greek public debt is still forecast to be equivalent to almost 180 per cent of gross domestic product this year. That is much higher than in emerging market countries, with which Greece is now compared, says Salman Ahmed, fixed-income strategist at Lombard Odier Investment Managers.

“We can get similar yields on much stronger countries – at least when you look at debt to GDP ratios,” he says..

5. Putting Australia’s housing bubble into perspective
Remember the times when the inner city of Tokyo was allegedly worth more than the whole of California combined?

That was of course at the peak of the Japanese housing bubble. Now it might well be Melbourne’s turn.

The total value of the Victorian capital has reached AU$1.2 trillion – or about five times Greece’s domestic product.

So what can be done about that? The Herald Sun has a few ideas – just don’t suggest this might be just another housing bubble.

We crossed the trillion-dollar mark back in 2011, but last year added $150 billion to our bottom line. Right now, we could cover almost five years of Greece’s annual gross domestic product, about $299 billion in 2011 according to United Nations figures. They’d probably consider selling for that. They could use the money. And we could use the Greek Islands.

If we’re not prepared to run a clearance sale, we should at least consider selling Brighton. It’s worth $16.2 billion by itself, about what Jamaica’s entire economy turns over per year. … Better yet, if we hawked our top ten highest valued suburbs we could claw back $122.5 billion. That would be more than 80 per cent of the $150 billion cost of the International Space Station. Think about it. Our own space station.

6. More space in cattle class probably means more cattle
Ten years ago, when the Airbus A380 was introduced, there was hope that this spacious aircraft would finally add a few extra inches to passengers travelling in economy class.

From experience we know airlines opted instead to put in extra chairs.

At the launch of Airbus’ new A350 long-haul jet, history is repeating. Its extra 30 centimetres of width has the potential to finally make travelling a little less painful, according to Chris Emerson, senior vice president of marketing at Airbus.

But you guessed it, this extra bit of space could actually make seats narrower, not wider. Instead of squeezing nine passengers in a row, now there could be ten.

Sometimes efficiency can be painful.

As for the passenger experience on the A350, Emerson touted the new jet’s wider-than-normal 221-inch cross section. He said the extra width on the wide-body jet would give customers a more-comfortable seat width of 18 inches – provided airlines that buy the jet don’t instal more than nine seats per row. While that nine-abreast count is the layout Airbus envisions for the economy class, airlines are free to configure the jet as they see fit. And that could include a “high-density” layout that would pack in 10 passengers per row in coach class. When asked for his thoughts on the possibility that Airbus’ A350 customers could opt for such a layout, Emerson responded “airlines know best” what works for the markets they serve.

7. Our future is in Asia but are we there yet?
The Asia New Zealand Foundation just released the results from its latest opinion poll on attitudes towards Asia. It shows that New Zealanders understand that our future is in Asia but it also reveals that there remain gaps in our knowledge about the region.

Unfortunately, there is still some scape-goating about Asians in New Zealand – and while we welcome Asian investors, we really do not want to cede any control.

Four out of five people (80 percent) polled in the 2013 survey believed Asia was important to New Zealand, up from 77 percent in 2012. But two-thirds said they knew only a little or almost nothing about the region. … Most New Zealanders (75 percent) agreed it was good for the New Zealand economy to have Asian companies investing in New Zealand businesses – an increase of five percentage points since last year. However, those interviewed in a follow-up forum felt that ownership and control of assets and organisations should remain in New Zealand. The survey also found that, nationally, New Zealanders were more likely to disagree (43 percent) than agree (33 percent) that rising house prices were due to Asian people buying properties. But the opposite was true in Auckland. Aucklanders were more likely to agree (46 percent) than disagree (31 percent) that Asian people were responsible for rising house prices.

8. Who suffers most from inflation?
US economist Tyler Cowen, writing in his blog Marginal Revolution, takes issue with Paul Krugman’s latest column.

In it, Krugman claims that inflation mainly affects the wealthy. In contrast, Cowen points out that rising prices are a problem for those who do not have the means to protect against them and who cannot renegotiate their salaries easily.

But is that enough to construct a conspiracy theory of inflation?

In other contexts, Krugman (correctly) stresses that price inflation lowers the real exchange rate of a country (and thus is not neutral, supporting the view that nominal variables really do matter). So one big group of gainers from domestic inflation are those who invest lots of money overseas, wait for some inflation, and eventually convert their foreign currency holdings back into dollars for a very high net rate of return. Which group of people might that be? The super wealthy of course. (This internationalization of returns for the super wealthy, by the way, is one big difference between current times and the 1970s.)

I am not suggesting that the very wealthy are out there pushing for higher inflation. But they are much more protected against such inflation than Krugman’s analysis suggests, and the middle class in protected service sector jobs is more vulnerable than is usually recognized. There is a reason why 4-6% price inflation has become the new third rail of American politics.

9. You can’t start saving too soon
Over at the British Daily Telegraph, Richard Evans demonstrates the power of compound interest with a simple illustration.

The message is simple: What you do not save earlier in your life, you will struggle to make up for in your later years.

Which will give you a bigger pension: saving for 40 years or just 10? Believe it or not, the answer is 10 – if those years are at the very beginning of your working life.

Someone who starts saving at the age of 21 and then stops at 30 will end up with a bigger pension pot than a saver who starts at 30 and puts money aside for the next 40 years until retiring at 70.

This astonishing outcome is entirely due to the power of compound interest – the way that investment returns themselves generate future gains. Having 10 extra years for compound interest to work its magic has the same result as all those years of extra contributions..

10. Quantitative Easing as financial morphine
Economist Bob Swarup, the author of Money Mania: Booms, Panics and Busts from Ancient Rome to the Great Meltdown, was a supporter of quantitative easing when it was first introduced.

But writing in City A.M. he now concludes that ultra-loose and unorthodox monetary policy has prevented a recalibration of the economy.

The palliative medicine has turned into a poison:

Most importantly, QE holds back much-needed structural change. A falling money supply was the symptom. Its deeper cause was a toxic build up of debt and misallocated capital. By keeping the patient in statis, QE propagates that zombie debt – Japan’s mistake for two decades. Simply put, we need creative destruction. Genuine sustainable growth requires a cleansing of the Aegean stables. We need to accept and exorcise the bad debts of the past, so that money can flow once again to where it is needed within the economy. Without completing this critical process of reallocation of capital, growth remains a mirage.

QE was once a necessary sedative. But we escaped the liquidity trap only to stumble into a cognitive trap instead. And that is perhaps the most terrifying bubble of all.

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