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Economics

The Hutch Report

The New Economic Hitmen

By | Economics, Finance, Politics

John Perkins original book, “Confessions of an Economic Hitman” and his current book, “New Confessions of an Economic Hitman” brought to light some of the strategies the US has used over the years in order to gain control of foreign reserves that American companies may want to seize, such as oil. 

According to Perkins, the method of achieving this end was to use external consultants such as the one he worked for. They would arrange large loans for those countries via the World Bank and its partner organizations. However, the governments in question never received the money. Instead, the money would be transferred, directly or indirectly, to American companies, including construction firms like Halliburton or suppliers like General Electric. These American entities would then launch infrastructure projects which may have included power grids, or industrial parks and highways. These projects generated huge profits. However, not surprisingly, those profits went to the American companies and a few rich local familes. In the end, these countries that were already weighed down by huge debts just saw their debts grow larger, which in turn pressured the already poor and middle class. 

Typically, a developed country with a dictator that sits on a perch makes for a soft target. Dictators are often propped up by failed systems like corrupt police force and military. They are usually the most eager to redeem their images so if you can take photos with them signing agreements about huge infrastructure projects it will help soften their soily images.  Therefore, they are happy to stand on the podium and tell their ill-informed, semi-literate populace about the development the government is bringing to their country. 

As an example, in the 70s, large loans were provided to build a power grid in Panama. The real goal was to force the then Dictator Omar Torrijos into a situation where he owed the US a lot of money in order to have something to blackmail him with because at that point, his bankrupt country would be beholden to them. As Africans would say, you hold both the yam and the knife. In 1977, Torrijos signed a deal with the US, which guaranteed that the government of Panama would have full control of the Panama Canal starting 1999. In 1981, he was killed in a car crash.

Omar Torrijos

Looking at the situation today with the number of sanctions and tariffs being thrown around one has to wonder who the principle targets of the current administration are. Russia? The truth is, Russia and the US have been playing spy games on each other for years. The real targets are the emerging economies. “I have no doubt that there are economic hitmen targeting emerging economies like Turkey’s,” Perkins said in an interview to the Turkish based Anadolu Agency. But Turkey is not the only country where the US has imposed sanctions and tariffs. Currently, sanctioned countries include the Balkans, Belarus, Burma, Cote D’Ivoire (Ivory Coast), Cuba, Democratic Republic of Congo, Iran, Iraq, Liberia, North Korea, Sudan, Syria, and Zimbabwe.

In today’s globalised world economic hitmen are no longer only US based. Today they may come from any number of other countries, including Russia and China. Globalisation has created huge opportunities for economic hitmen around the planet.

Trump’s administration sees infrastructure as one of the key areas to boost US economy. However, the recently published Infrastructure plan has been criticised for lack of money and is highly dependent on private capital. The US is already running large deficits and the national debt now currently stands at $21.8 trillion. 

China, with its strong infrastructure achievements and the largest amount of foreign exchange reserves (China has by far the largest foreign currency reserves with over two and a half times more than the second largest reserve holder, Japan. When China and Hong Kong reserves are considered together, the total is $3.6 trillion), is constantly looking for low-risk long-term investment projects to achieve asset preservation and appreciation. By targeting the US, China could balance its foreign exchange levels while accelerating the rejuvenation of American infrastructure. This would also transform China into a job creator in the US. 

The Hutch Report

The Hong Kong–Zhuhai–Macao Bridge, 55 kilometres long.

China is currently employing this strategy throughout Africa along with their One Belt, One Road initiative. China has been the largest trading partner of Tanzania for many years with some 350,000 Tanzanians doing jobs related to trade with China. Also Chinese companies have built a number of mega projects in Tanzania, including roads and bridges, creating about 150,000 jobs. 

Interestingly, on his last trip to the continent just before being replaced, Rex Tillerson said that African countries should be careful not to forfeit their sovereignty when they accept loans from China, the continent’s biggest trading partner.

Would Trump be open to outsourcing the development of the US infrastructure to Chinese firms? The short term boost to Trump’s reputation may blind him to the longer term complications. Could the US itself become a target of the economic hitmen?

The Hutch Report

The Slippery Slope of Oil

By | Economics

WTI Oil has been falling steadily from the October high of $76.9, trading currently at $50.96. That is a 33.7% decline in just over a month and a half. Although this may be good news for the end consumer it is causing serious problems elsewhere.

One of the more complicated situations regarding the price of oil has arisen in the province of Alberta. In fact, Alberta is currently in a crisis as the province’s oil is being sold at a discount of about $45 a barrel to WTI. Alberta Premier Rachel Notley has said the price gap between Canadian and U.S. crude is costing the Canadian economy $80 million a day.

You would think that oil being sold for that much of a discount would be bought up in no time, however the reality is more complicated. Where the oil is produced geographically matters, because it needs to be transported from its point of production to a refinery. This impacts the price received for the oil.

Tim McMillan, president and CEO of the Canadian Association of Petroleum Producers, said the main issue is there isn’t enough pipeline capacity. In late August of this year, a Federal Court of Appeal ruling put a halt on the Trans Mountain expansion project; in 2017, the federal government scrapped the Northern Gateway pipeline; and Keystone XL is still hung up in legal wrangling in the United States.

A Scotiabank Economics report ,released this week echoed that point where they said, “Alberta’s oil producers are facing an extraordinary challenge caused by pipeline bottlenecks combined with growing production.” As of 2017, the oil sands were filling up some 2.7 million barrels per day, according to Natural Resources Canada. When that’s combined with other oil sources, the oil awaiting export is roughly the same as pipeline capacity from Western Canada, and so there’s a pinch point: If pipeline capacity is reduced for maintenance, or if companies book pipeline space, but don’t actually send oil — so-called air barrels — then there’s a backlog.

So not only is the falling price of oil exacerbating the current situation in Alberta, we may expect to find a similar situation south of the border. The Permian Basin, which covers 75,000 square miles over West Texas and southeast New Mexico, is the most prolific oil producing basin in the country – so much so that it’s become difficult to find ways to get the product to market. Wells Fargo recently projected that oil pipeline constraints in this area may last until 2020, versus its previous prediction of the third quarter of next year. That means more transport by rail or truck.

The International Energy Agency (IEA) wrote just recently in a report on energy investment that, “Higher prices and operational improvements are putting the US shale sector on track to achieve positive free cash flow in 2018 for the first time ever.” How quickly things can change as the sector may be forced to relive the last downturn where the ink on the chapter 11 filings has hardly had time to dry.

In 2014, the market downturn forced a bunch of companies operating on the edge out of business. Nearly 100 shale companies filed for bankruptcy in 2015 and 2016. Oil was trading around $40 at the time. Although this downturn forced drillers to become more efficient, the BNEFestimated that break-even prices still range from $31.61 a barrel for the best Permian Midland wells to $188.25 for the weakest Permian Delaware wells.

GlobalData Energy came out with an interesting report in June that analysed recent wells drilled by 26 operators in the area. It found that the break-even oil prices for wells with lateral lengths of 4,500 to 10,500 feet ranged from $21 to $48 per barrel. So if you assume somewhere from $30 to $50 breakeven then we can expect to soon see another flood of bankruptcies as oil continues to tank.

The Hutch Report

Vancouver Real Estate – Is the bubble deflating?

By | Economics, Politics

“It is different this time,” “This is the place everybody wants to be,” has been the talking points when referring to the impressive rise of Vancouver and its real estate market. Unfortunately all markets that experience a rapid escalation of asset prices, as we have seen in Vancouver, eventually experience a painful contraction whereby, as macro investor Raoul Pal puts it, “The big uglies come out.” Are we starting to see what those big uglies are in the Vancouver real estate market?

Vancouver has been the victim of a number of economic events in the world that have culminated in the development of its current dangerous real estate bubble. Central bankers driving interest rates down to historic lows and keeping them there for years, the rapid rise of China’s economy along with the massive number of its newly printed Chinese millionaires, the rise of corruption in China, the exodus of this corrupt money along with Chinese government efforts to reign it in, are just a few of these events.

Life in Vancouver, where the talk of real estate riches and Vancouver suddenly becoming the place to be, has become the favourite subject among its residents, although they may not be aware that other regions in the world have experienced the same impact and will experience the same result. 

Top residential real estate brokerages in the US have been promoting US homes to investors in China for years. Brokerage firms in Canada, Australia, New Zealand, and other countries have done the same. They have set up units in China and have partnered with Chinese real estate portals, such as juwai.com. However, one place where the real estate bubble is most prevelent is in China itself. According to a recent report by Bloomberg, a fifth of China’s housing is empty. That’s 50 Million homes! 

This is what happens when rampant speculation in a market is not contained. Unfortunately when there is money to be made people disregard the splitting hangover that the all night party can bring. 

So what has the impact been in Vancouver?

For too long Vancouver disregarded the longer term risks and turned a blind eye to the massive amounts of corrupt speculative money that was pouring in from China. The low interest rates fuelled the building in Vancouver in order to satisfy the insatiable thirst for Vancouver real estate. (This was pretty much the same story in Australia and New Zealand). There was a rapid rise in prices pushed up by Chinese buyers, in addition to Vancouver residents rushing into the market for fear of missing out. The result was Vancouver real estate became quickly unaffordable to many of its own residents. 

Only recently has the government tried to halt the rise. In 2016, Vancouver became the first Canadian City to collect an empty homes tax, charging one per cent of the home’s assessed value if the owners are not living in it or are renting it out for less than six months. In addition, the government also imposed a 20% foreign property buyers tax.  

Elsewhere, New Zealand’s parliament banned many foreigners from outright buying existing homes in the country – a move aimed at making properties more affordable. New Zealand is also facing a housing affordability crisis which has left home ownership out of reach for many.

Canada, New Zealand and others are not the only ones taking measures to reign this in. China has begun cracking down. Over the last decade, an estimated $3.8 trillion in capital has left China. Net foreign direct investment over the same period of time has amounted to $1.3 trillion, leaving the country with a net loss. To reduce capital flight, the Chinese government has developed a complex system of capital controls, such as limiting transfers of $50,000. However, that has not stopped the Chinese from being creative. The CEO of a Chinese company moved $750,000 from China to Metro Vancouver for a real estate deal with the help of nine strangers who each brought $50,000 into Canada for “tourist purposes,” according to a B.C. Supreme Court judgment.

But in spite of these controls the damage has been done and now increasing interest rates may just be fuelling the fire as the news starts to trickle in. 

According to economists at the Royal Bank of Canada, owning a home in Vancouver is the most unaffordable it has ever been in any Canadian City. In fact, they found affordability to now be “at crisis levels” where it would take a record 88.4 per cent of one’s income to cover ownership costs. Statistics Canada reported that, “Credit market debt as a proportion of household disposable income increased to 169.1 per cent as growth in debt outpaced income. In other words, Canadians owed $1.69 in credit market debt for every dollar of household disposable income.”

Credit reporting agency TransUnion released data showing that Vancouver residents have the highest debts among those who are in major cities, owing an average of $38,753 in non-mortgage, consumer debt through the first quarter of 2018.

Vancouver residents, and Canadians in general, are growing increasingly anxious about their ability to handle higher interest rates, with a new survey showing a rising proportion of consumers fear they will be pushed over the brink. Rightly so, they are concerned mostly about their high-ticket items such as a mortgages and car loans.

As we began this article, the explanation for Vancouver’s real estate rise was its attraction as a city, at least according to many of its residents, its natural beauty and idyllic west coast location. Although in my opinion this is true (considering it is my home town) to a point. There is a difference between speculation and purchasing a home to live in. The first clue that we were dealing with speculators, as is the case in China, should have been the number of empty houses and condos in Vancouver (which was the reason the city eventually created the empty homes tax). 

What has been the effect of these controls on speculators?

Vancouver is now ranked as the worst place in the world for luxury homebuyers seeking a return on their investment, according to a global survey of 43 “prime residential” cities. The Knight Frank Prime International Residential Index found that, while luxury property prices globally were up an average of 4.2% in the third quarter, compared with the same period in 2017, they fell 11.2% in Vancouver, where luxury home sales have tanked. No other Canadian city made the list, and Vancouver ended up ranked No. 43.

For those in Vancouver who refuse to believe bubble talk and believe that the Chinese will keep purchasing and supporting the real estate market for years to come, they may want to rethink that. Beijing has warned of its zero tolerance for dual nationality. Now some foreign citizens who held on to their Chinese identity documents fear the consequences of returning, according to South China Morning Post. In addition, it is hard to believe that the Chinese will be rushing to give up their Chinese citizenship at a time in history when China promises to be the next great economic powerhouse. 

The problem with living through a bubble is often the most vulnerable get hurt, as we saw very clearly during the housing bubble and financial crisis of 2007 in the US. The same is most likely to be true for the Vancouver residents that extended themselves purchasing overpriced real estate that they could ill afford. The international speculators will move on as they continue their worldwide search for return. As in other locations, it is likely that they will not hang around long enough to see the real damage that remains once all the air has been taken out of the bubble. 

The Hutch Report

A Day of Carnage in the Trading Rooms

By | Economics, Finance, Politics

Thirty one years ago today, on Oct. 19,1987, the Dow Jones Industrial Average plunged 22.6%, its largest one-day percentage-point drop ever.

You may have noticed that the financial media has started to highlight the point drops as opposed to the percentages. To say the Dow lost 500 points makes better news than saying it lost 2%. In percentage terms though this years recent plunges pale in comparison to what “could” happen as we have seen in history.

Here are five of the worst stock market crashes in U.S. history, based on daily percentage losses (source: ajc.com):

Oct. 19, 1987

Percentage change: -22.61 percent

About: Known as “Black Monday,” this devastating crash began in Hong Kong, spread to Europe and then hit the U.S. hard.

Oct. 28, 1929

Percentage change: -12.82 percent

About the crash: The Wall Street Crash of 1929, also known as the Great Crash or the Stock Market Crash of 1929 started on Oct. 24 and signaled the beginning of the 12-year Great Depression. Black Monday, the fourth and worst day of the crash, saw a drop of 12.82 percent.

Dec. 18, 1899

Percentage change: -11.99 percent

About the crash: During the Panic of 1896, the U.S. experienced an acute economic depression caused by a drop in silver reserves and deflation.

Oct. 29, 1929

Percentage change: -11.73

About the crash:  Black Tuesday was the fifth day of the the Wall Street Crash of 1929, also known as the Great Crash or the Stock Market Crash of 1929 that started on Oct. 24 and signaled the beginning of the 12-year Great Depression.

Nov. 6, 1929

Percentage change: -9.92

About the crash: Just a week after the height of the 1929 Stock Market Crash, investors saw another dip.

As many often refer to these numbers when speaking about this event the real point of interest should be in what they were saying back then, which not many financial media tend to refer to. Ironically they were saying many of the things they say today.

We looked back at a Nightly News Broadcast of that time in order to gain a better understanding of the mindset of the time. You would be advised to watch the broadcast because in the words of Philosopher George Santayana, “Those who cannot remember the past are condemned to repeat it.” (See The Nightly News Broadcast October 19, 1987 at the bottom of the post)

The 1987 crash lost much more than the crash of 1929, and although (as they said at the time), “Conditions today are much better than they were then,” “today’s precipitate decline struck fear in hearts and pocket books of even Wall Street veterans.”

All the same actors showed up as they do today with the same speech tracks. New York Stock Exchange Chairman at the time, John Phalen, tried to be reassuring. “We are extremely fortunate today that the country is in a very strong position.”

The word of the Economists was that they were worried that the market plunge at the time could impact the psychology of even those that didn’t own stocks. They worried the consumer would stop borrowing and spending which could grind the economy to a halt. Compare those worries of the time to today. They are the same. The big difference is that today consumers are already heavily indebted. They are carrying mortgage debts, auto loan debts, student loan debts and credit card debts that are far higher than they were in 1987.

The broadcast pointed out that, “A week ago most economists were saying that the stock market decline was merely a correction.” This is also familiar territory. Of course it is always a correction until it isn’t, however making that judgement before the fact is just a guess. On October 19, 1987, that guess turned out to be very wrong. They went on to say that, “Today’s plunge was so huge, so shocking, that no economist, no Wall Street analyst was willing to predict where it would end.” Irony so thick you could cut it with a knife.

By the end of the day, everyone was looking to Washington for some action that may help stop the carnage. At the time President Ronald Reagan ignored the plunge and continued to “brag” about the Reagan recovery. This doesn’t sound to different to anything we would expect today. Although we can probably assume that no matter what kind of serious drop that the stock market may go through in the future, Trump will be quick to blame the Federal Reserve (however that will not stop him from taking credit it for it if it keeps moving up).

All in all, it is a fascinating 9 minutes to watch. We shouldn’t expect to hear anything different today than we did 31 years ago and that means we should have a pretty good idea of what to expect in the future.

The Hutch Report

Understanding the Face of China

By | Economics, Politics

The current Trump trade war with China and the fact that The Shanghai Composite Index is off roughly 24% for the year has placed a lot of the recent news focus on China. However, understanding the Chinese takes much deeper digging into the Chinese mindset as opposed to just looking at current economic numbers. The Trump administration strategy towards China may produce some short term benefits in terms of public support but the Chinese are working on a much longer timeline with which to accomplish their goals.

The best way to understand China is to be there and speak with those with whom we have business relationships, which is exactly how we gained the following insights.

In order to get to where China is today, they required expertise that they didn’t originally have. According to Professor Paul Gillis, a former head of PwC in China turned academic at Peking University’s Guanghua School of Management, and now the pre-eminent foreign analyst in China’s accounting industry, the then big eight western accounting firms clearly saw the opportunity developing in China back in the 1980s. 

“They began building up representative offices to advise foreign firms entering China, at first often working out of hotels. By 1992, they had won the right to audit, working with Chinese partners, and were helping to develop China’s accounting standards. They pulled in all manner of outside experts to help them understand the country.”

The domination of Chinese accounting by four foreign multinationals soon became a source of annoyance in the official halls of Beijing. Paul Gillis wrote that by 2006, Ding Pingzhun, director-general of the government-aligned Chinese Institute of CPAs (CICPA), spoke of the Big Four as firms that “lord themselves arrogantly across China”. 

These firms indirectly and or directly have under their tutorship approximately 60% of the Corporate sector in China. Because of this China knows that the US is intimately familiar with China’s business internal operations (shadow banking and corruption) and thinks they may be using this knowledge to form policy to secretly undermine them and weaken them.

For this reason, China believes that the US has been planning this attack using tariffs since 2000 from the Republican administrations. The expected George W. Bush to implement tariffs during his Presidential administration, however, the attack on New York on 9/11 most likely derailed the initial opportunity. The 2008 crash most likely took away the second opportunity for Bush to apply any meaningful tariffs against China. By the time Trump came along and implimented this strategy the Chinese were not surprised as they had been expecting such a move for some time. 

The Chinese understand the recent US moves to reduce corporate taxes in order to repatriate money offshore and induce these companies to return their manufacturing bases back to the US. The Chinese also realise that an agreement between North Korea and South Korea (with the US brokering) could create a much cheaper labor base. The threat is that this could take away a lot of labour intensive industries from China.

They believe that the tariff program was put in place to try and weaken or slowdown China’s growth in manufacturing and thus their world influence. It is not a secret that China has been going after markets in the Middle East, Africa and Central America spreading their influence in order to breakaway from any stranglehold that the US may currently have on them. In addition, to facilitate this in the future China has taken on the massive development of the One Belt, One Road initiative which if successful will change the face of international trade. 

China is playing on a much longer timeline so they are prepared for some pain and suffering. In China, Xi has now solidified his position for life. China knows that the US changes party power every 4 years and is betting that the democrats get back in and reverse the Trump plan.

In order to deal with the Chinese one has to understand some important character traits. 

Of all the idiosyncrasies of Chinese culture, the concept of “Face” is perhaps most difficult for Westerns to fully grasp. And because “saving face” is such a strong motivating force in China, it’s also one of the most important concepts in understanding the Chinese Mind. It goes back centuries and appears in many Chinese sayings and proverbs. 

“Men can’t live without face, trees can’t live without bark.”

(ren hou lian, shu hou pi)

“A family’s ugliness (misfortune) should never be publicly aired”

(jai chou bu ke wai yang)

A traditional insult is to say that someone “has no face”.

(mei you mianzi)

Similarly, one of the worst things is to “lose face”.

(diu lian)

The management of “Face” goes much deeper than just impression management (or “protecting and enhancing your ego”) in the Western sense. Although nobody, regardless of culture, wants to look bad or have their ego bruised, the Chinese concept goes beyond the narrow Western concept of face (and is perhaps closer to the Arab concept of “honour”).

While an American businessperson might be respected back home for his frankness and being a “straight-shooter,” he would likely be viewed in China as uncultured, overbearing, and rude.  President Trump’s remarks against the Chinese on the world stage do not, by any means, go unnoticed by the Chinese public.

The Hutch ReportDuring Hu Jintao’s 2006 visit to the US, there were a large number of missteps on behalf of the Bush administration that were believed to be an intentional campaign to make China lose face on the international stage. If this was truly the case, the Chinese have not forgotten. 

The Hutch ReportThe current trade war should be looked at as an economic battle that could drag on for some time and not as a short term tactic on behalf of the Trump administration. They have opened up Pandora’s box. According to a recent article in the Washington Post, the tough tone on behalf of the US effectively ties Xi’s hands. 

“James Zimmerman, former chairman of the American Chamber of Commerce in China stated, 

“Getting the Chinese to the bargaining table should be all about face-saving — not a chest-thumping exercise, Xi has no choice but to stand firm and stand tall.”

Trump’s bravado approach to try to win concessions from Beijing has provoked a public fury that could ultimately derail his efforts. Although the Trump administration believes that a trade war can be won and that they are in a position to win against China, it should be perfectly clear that today’s China is a much stronger adversary on the economic, military and cyber front, than they ever were. If their back is against the wall it will only be a matter of time before “Xi hits the fan.”

The Hutch Report

The Ghostly Budget

By | Economics, Finance, Politics

It appears that the dark halls of the US Military Complex could teach Trump, Cohen and Manafort  a few things about shadow budgets and hiding money.

Anybody reading this may have come across a story that grazed a few pages a year ago. However, surprisingly it didn’t seem to make more noise among the public than it did at the time. The story involved some unsupported adjustments, or spending by the US army that amounted to roughly $21 trillion. That number is not a typo. If true, it would mean that the US army had spent an unauthorized amount that would equal the current sum of the national debt. Even though the story may not have created a very large public disturbance, it did put a few people in the Pentagon into action. We wanted to find out where the trail was leading. 

For those not familiar with the case, it all started when Dr. Mark Skidmore, a PH.D. in economics and Professor and Morris Chair in State and Local Government Finance and Policy at the Michigan State University, was listening to an interview with Catherine Austin Fitts, former assistant secretary of Housing and Urban Development. In the interview as Skidmore explained “Fitts refered to a report that had come out in 2016 by the Office of the Inspector General (responsible for providing some accountability and tracking of financial activity of the Federal Government).” The report indicated that in fiscal 2015, the US army (with a budget of roughly $122 billion) had adjustments of $6.5 trillion. Because of Dr. Skidmore’s experience and knowledge base, he had some serious doubts about the quoted figure and assumed they must have meant $6.5 billion. He looked at the report himself and to his surprise found that it was not an error. 

This prompted Dr. Skidmore to suggest to Fitts to investigate the issue further.  So during the summer, two MSU graduate students searched government websites, especially the website of the Office of Inspector General (OIG), looking for similar documents dating to 1998. What they found was far beyond what they expected to find. They found documents indicating a total $21 trillion in undocumented adjustments over the 1998-2015 period, of which $11 trillion were directly linked to the US Army.

Dr. Skidmore’s work was able to show that there was something very broken within the budget process. By October 5, 2017 they suddenly discovered that the link to the original OIG report “Army General Fund Adjustments Not Adequately Documented or Supported” of July 26, 2016 had been disabled. Within several days, the links to other OIG documents that had been identified in their search were also disabled. However, Dr. Skidmore and his team had the foresight to copy the July 2016 report and all other relevant OIG-reports in advance and re-post them (The original government documents and a report describing the issue can be found here).

On December 7, 2017, Pentagon officials announced that the Defence Department was beginning the first agency wide financial audit in its history, 

By June 2018, Dr. Skidmore wrote the following update:

“In late May 2018, a graduate student at Michigan State University found on the OIG website the most recent report for the DoD, which summarizes unsupported adjustments for fiscal year 2017. However, this document differs from all previous reports in that all the numbers relating to the unsupported adjustments were redacted. That is, all the relevant information was blacked out.”

So is this situation just over exaggerated with hyperbole and blacked out documents for more dramatic effect? Governmental departments are extraordinarily inefficient organizations. It often requires a number of documents to be signed off before one can order some additional pencils. 

Could such an inefficient department have the smarts and tools to be able to disguise such a massive amount of money from the taxpayers eyes? Well here are some other incidents which shows they never stop short of giving it their best try. 

December 5, 2016, The Washington Post reported that the Pentagon had buried an internal study that exposed $125 billion in administrative waste in its business operations amid fears Congress would use the findings as an excuse to slash the defence budget.

February 5, 2018, a leading accounting firm said in an internal audit obtained by POLITICO, that one of the Pentagon’s largest agencies couldn’t account for hundreds of millions of dollars’ worth of spending, (curiously just as President Donald Trump was proposing a boost in the military budget.)

On August 13, 2018, President Donald Trump signed a military budget boosting the Pentagon’s spending by $82 billion in the next year—a spending increase that dwarfs the entire military budgets of most other nations on Earth. (Russia, for example, will spend an estimated $61 billion on its military this year). With the increased spending included in this year’s National Defense Authorization Act (NDAA), the Pentagon will get to spend more than $700 billion next year. The budget hike was a priority for Trump and was approved by Congress as part of a March spending deal that saw spending on both defense and domestic programs hiked by about $165 billion—smashing through Obama-era spending caps.

On September 17, 2018, it was reported that the Pentagon had massively overestimated, for the second fiscal year in a row, how much its new retirement system would cost.

All that is required is a quick search of the Pentagon and their funding requirements to discover that this is a game that has gone on for a long time. There seems to be a budget for some and a black budget for others in the government.  In the end, it is the taxpayers that are flipping the bill for all the spending. In a Dec. 8 Forbes column that he co-authored with Laurence Kotlikoff, Skidmore said the “gargantuan nature” of the undocumented federal spending “should be a great concern to all taxpayers.”

The fact that these previous reports along with the revelations of Dr. Skidmore and Catherine Austin Fitts have not caused people to become enraged is surprising. This just seems to show that the general public view towards the current levels of greed and corruption are still complacent.  Although the US dollar as a reserve currency may allow the government to get away with many of their spending habits and shadow budget operations for the moment, the day it’s removed will cause some serious repercussions. 

We can already see many signs of the international community getting frustrated with strong arm tactics by the US and adjusting appropriately in order not to be held hostage anymore by the US dollar reserve status.

Reuters recently reported, 

“The U.S. dollar’s share of currency reserves reported to the International Monetary Fund fell in first quarter of 2018 to a fresh four-year low, while euro, yuan and sterling’s shares of reserves increased.” 

It is no longer a matter of if, but when.

The Payments War: Who will the winner be?

By | Economics, Finance, Technology

When mentioning Payments War, some people think of Shopping Wars and fist fights at Walmart on Black Friday. This article is not about that. The Payments Wars are actually multiple wars. A war on cash. A war for your shopping behavior and data. A war for your wallet. These wars are raging both online in the digital world as well as offline in the analog world and the two worlds are converging as combatants vie for cashless digital transactions for offline payments. Why should you care? Every time you buy something, whether you like it or not, it is over you and your data for which the battle is being fought. Your payment behavior and your payment data is what they are after. How will you pay and which platforms will be used? Will that be cash, credit card, debit, PayPal/Venmo, Square, Bitcoin and other cryptocurrencies, Apple Pay, Samsung Pay, Amazon one-click payments, Visa, Mastercard, Discover, Amex or even a credit line offered at the time of checkout?

The Hutch Report

Many may not realize this war going on right before their eyes each and every day as they buy their coffee, their lunch, their gas, groceries, electronics and anything else. And it has been going on for a long time. The winner wants to be the master of how consumers pay for things. As hinted above, the reasons are several-fold. One is, that at scale, there is money to be made processing payments and slicing a few cents or more off of each transaction which amounts to massive amounts at scale. To put this in some context here were the quarterly revenue volumes reported by a few of the combatants in the summer of 2018

A 2017 report by Statista estimates that total payments revenues, which were 1.6 trillion US dollars in 2016 will reach 2.2 trillion US dollars by 2021. That is what the processors are earning on payments. The overall payments volume, what PayPal calls TPV or Total Payment Volume, is a much higher amount.

These massive volumes of payments occur each day online, in stores around the world, at market places, peer to peer, travel and transportation, domestic services, credit payments, business to business payments, cross border and international payments… in other words, there is a lot. We were unable to find exact figures for the total value and number of transactions comprising annual payment volumes including cash and non-cash world-wide, but you can easily see that this number is easily in the trillions. Effectively it would probably be very close to the sum of the GDP (gross domestic product) of all countries – in other words the Gross World Product which is currently near $80 Trillion dollars a year.

 

 

 

Alibaba, the world’s largest (454M buyers) online market place processed $547 Billion of payments in China alone in 2017. So while $547B is large, it is a small fraction, less than 1% of world GDP … or total world payment volume.

 

 

 

 

 

 

 

 

 

Secondly and some may argue even more valuable than the processing fees, generating revenues for payments companies such as the ones mentioned above, is the data that can be collected on consumer and merchant behavior.  The Hutch Report recently chronicled how data is quickly becoming the new biological nerve gas. The credit card associations assign a merchant category code to each merchant and this code corresponds to the type of business or service the company offers. But this is just the tip of the iceberg, data is collected for each transaction on the amount, the location, the date and time, the type of transaction (purchase, refund, withdrawal, deposit, etc), the type of account, card number, identity of the card acceptor (eg. merchant), information on the terminal used for payment, and much more. Apple already has over 450 million credit cards on file related to iTunes, the iOS Appstore, and Apple TV. In addition to knowing what media you consume, with Apple Pay, they will know even more about you. In addition to advertisers and the merchants themselves, payments data is also super interesting to investors and market speculators. Investors and speculators will go to great lengths to collect data in order to build an edge for themselves. There are now even companies such as RSMetrics that produce and sell aerial imagery of retail outlet parking lots and production facilities. Payment data is much more granular and refined. In addition, the Government also loves digital data, particularly digital cash because then they can completely monitor it, control it, and even charge negative interest rates quite easily if they so choose.

Given the size of the battlefield, a fragmented regulatory landscape and the existence of a plethora of consumer segments, consumers and consumption types … these wars for how you pay and how your payments data is collected will continue to rage for some time.

The Hutch Report

Anchors Away! Is the US retail boat sinking?

By | Economics

If you put one or more buildings together and form a complex of shops representing merchandisers, add to that interconnected walkways enabling visitors to walk from unit to unit, you get what is known as the great American shopping mall. 

1,500 malls were built in the US between 1956 and 2005, and their rate of growth often outpaced that of the population. They replaced main street and became the epicentre of communities, the foundation of retail economies, and the place for teenagers everywhere to see and be seen.

At the heart of these malls has been the main stays of American retail, the department stores. They have been come to be known as the “anchors.” Every mall has them and it is these stores that make up a large portion of the retail space being dominated by one brand. Without them, there is a very large hole to fill. 

Malls became so popular over the years that everybody wanted in until the point where the market became saturated. “We are over retailed,” according to Ronald Friedman, a partner at Marcum LLP, which researches consumer trends. There is an estimated 26 square foot of retail for every person in the US, compared with about 2.5 square foot per capita in Europe. Howard Davidowitz, famed retail analyst says, “the US has 5 times more retail space per capita than that of Japan, Canada, UK or France.”   

Like anything else, the good times were bound to come to a halt. By the mid-2000s, the decline began slowly. The rise of the internet brought with it the rise of online shopping. The financial crisis of 2007 – 2008 brought a blow to retail that led to a drop in sales and foot traffic at big-brand retailers like Sears, JCPenney and Macy’s that anchored many of the country’s malls. Between 2010 and ’13, mall visits during the holiday season, the busiest shopping time of the year, dropped by 50%. It is clear from the chart below that Sears was badly wounded in 2007 and never recovered, in spite of all the promises of Eddie Lampert to turn the struggling retail giant around.

The Hutch Report

When Sears merged with K-Mart in 2005, the two chains had a total of 3,500 US stores between them. As of May 5, 2018, Sears Holdings operates 894 retail locations under the mastheads of Sears (506 full-line and 23 specialty stores, for at total of 529 locations) and Kmart (365 locations), though after a round of closures announced on May 31, that number will drop to about 820.

In August 2016, Macy’s announced the planned closure of 100 stores, or about 15% of Macy’s store base at the time. 

JC Penney has about 600 mall-based stores and another 400 smaller standalone stores in smaller markets. JC Penny announced and closed 140 stores back in 2017. The King of Prussia Mall is a 2.8 million-square-foot shopping center outside Philadelphia. The 50-year-old complex has more than 50 food venues and a concierge lounge. However, a J.C. Penney department store closed in 2017 as one of the planned closures, created a hole in the anchor-store lineup.

The Hutch Report

The closings of these stores are having an obvious impact on shopping malls across America. The malls that are not able to find an anchor to replace the legacy department stores are seeing their foot traffic dry up as the remaining stores in the mall close up or move, leaving an empty shell. Industry experts say 25 percent of US malls likely will close in the next five years, or about 300 out of the existing 1,100.

According to a recent Credit Suisse report (Credit Suisse US Retail Store Closure Index), 2018 is on track for another peak footage closure year. It shows the US retail industry is tracking to an annualized -59% YOY reduction in store unit closures in 2018 (after hitting an all-time high in ‘17). The closures are skewing toward much bigger box concepts (Toys R Us, Sears, Sam’s). The report states, “We expect elevated closures to remain a primary operational distraction and stock risk for the US retail space for several years.”

The Hutch Report

A report by Cushman & Wakefield, states, “There were nearly 8,500 store closures in 2017, surpassing the number that occurred during the Great Recession. Closures in 2018 are expected to match or exceed that level. Announced store closures have reached approximately 4,500 year to date.” Cushman & Wakefield estimates that this figure will reach over 9,000 this year.

As we have seen many times before, there is also that familiar Gorilla at the front door waiting to make its mark on the brick and mortar market! Jeff Bezos and Amazon are making inroads into the apparel space. According to Morgan Stanley, the e-commerce giant will become the top player of the US apparel industry in 2018, having gained 1.5 percent of market share last year. To date, Amazon trails only Walmart to claim the top spot among other apparel retailers Target, Kohl’s and TJ Maxx.

The Hutch Report

Should this be something for brick and mortar retailers to be worried about? Last year Fitch Ratings published a report that presented how a “hypothetical” rapid rise in Amazon’s U.S. apparel market share could have significant credit implications for existing retailers, REITs and CMBS (Commercial Mortgage Backed Securities) transactions.

“The Fitch shock scenario assumes an accelerated three-year apparel market share shift to Amazon.com as a price-competitive and convenient alternative to traditional in-store purchases. The hypothetical rapid growth in Amazon’s apparel market share to 25% by 2020 could cut apparel retailer margins by around 300 basis points, pushing several retailers toward financial distress. Assuming Amazon’s share gains are concentrated in lower price points, low to mid-tier apparel retailers, including JC Penney, Kohl’s and Dillard’s, would face intense competitive pressure in such a scenario.”

The focus of our article on troubled anchors did not go unnoticed by Fitch. 

“REITs owning regional malls with high exposure to troubled anchor stores and a less diverse tenant base would face heavy cash flow pressure. We estimate that as many as 400 of approximately 1,200 US malls could close or be repurposed as a result of retailer liquidations and square footage reductions.”

Although online has picked up some of this business and will continue to do so, the reduction cannot all be attributable to e-commerce. The desire to grow and get bigger clearly over stepped its boundaries leaving a glut of retail space on the American market. Increasing consumer debt loads in the way of car loans, credit card loans, and student loans are not positioning the consumer to be in any position in the future to come to the rescue. In fact, roughly 10% of employment in the US is in retail. All these additional closing will only put the consumer in a more precarious situation.

The death of the great American shopping mall may be a bit premature, but for the moment it is “Anchors Away” and unless these malls find a way to fill the hole or reinvent themselves fast the future doesn’t look so bright. 

The US Economy – Miracle or Mirage?

By | Economics

The economy of a country is a key talking point of most politicians, and rightly so. If you preside over a strong and growing economy, your political reign is reflected in a positive light.  If the economy of a country is weak as you enter, it will often be deflected and blamed on the predecessors faulty policies. However, there are times when the economy is struggling and the incumbents in power, making changes to improve it, will often point out the most impressive aspects, and mask over the weaknesses in order to convince the voter base that they are succeeding. 

My uncle had a saying, “When your neighbour is out of work, it is a recession; when you are out of work, it is a depression.” Your current personal economic situation will influence how you perceive the strength of the greater economy and what people are saying about it. If you are working in an affluent environment you may not perceive anything is wrong. You have money to go out to dinner, go on vacation or buy that new car you have had your eye on. In other words, your confidence in the greater economy will dictate your spending patterns. There is the counter situation, where you have no work and have essentially stopped looking, yet the financial media and politicians in power are telling you how strong the economy is. If they believe it, it may motivate people to go back to school and adapt their skills to the current job market. If they don’t believe it, they may weather the storm and pull back their spending (Nordstroms is off the table for now, time to head to Walmart). If enough people don’t believe it the true economy will eventually show its true colours no matter what the media and politicians say. 

So what is the true story? There are many economic indicators that are used to track the health of the economy. We looked at these indicators to see if they do provide some kind of clarity or, like many things, it is basically our perception of the current economic state that makes it strong or weak. 

Gross National Income (GNI) and Gross Domestic Product (GDP) are often used to judge the growth of the economy. For most nations there tends to be little difference between GDP and GNI, since the difference between income received by the country versus payments made to the rest of the world tends not to be significant. For example, according to the World Bank,  the U.S.’s GNI was only about 1.5% higher than its GDP in 2016. 

The graph below shows the Real GDP growth rate of the United States from 1990 to 2017 (GDP being the market value of all final goods and services produced within a country in a given period). The Real GDP growth is adjusted for price changes, as inflation or deflation and is chained to the U.S. dollar value of 2009. The Real GDP increased by 2.3 percent in 2017.

The Hutch Report

It takes capital to fund growth and countries will increase their debt loads to increase that growth but if the growth doesn’t come they find themselves in the difficult situation of struggling to pay back the debts. The debt-to-GDP ratio is the ratio of a country’s public debt to its gross domestic product (GDP). By comparing what a country owes with what it produces, the debt-to-GDP ratio indicates its ability to pay back its debts. The US recorded a government debt equivalent to 105.40 percent of the country’s Gross Domestic Product in 2017. Government Debt to GDP in the US averaged 61.70 percent from 1940 until 2017, reaching an all time high of 118.90 percent in 1946 (funding for World War II had something to do with that) and a record low of 31.70 percent in 1981. At the moment, it doesn’t appear to be moving in the right direction.

It should be pointed out that the GDP is made up of Personal consumption + Investments + Government expenditure + Net Exports. Consumption makes up 70% of this GDP number. As mentioned above, if the consumer is in a good mood and confident about the future they will go out and spend. Many will even use credit to charge those purchases and pay another day. However, if they get worried they will pull back their spending and start saving. So in a sense, “So goes the consumer, so goes the economy.” 

The personal saving rate is calculated as the ratio of personal saving to disposable personal income and refers to these strategies of accumulating capital for future use by either not spending a part of one’s income or cutting down on certain costs. In 2017 it amounted to 2.4 percent, as opposed to 10.4 percent in 1960. This was equivalent to just over 384 billion U.S. dollars in the fourth quarter of 2017. In June 2018, the personal saving rate in the US suddenly spiked and amounted to 6.8 percent.

The Hutch Report

It is also worth looking at the household debt to income levels of the consumer to know if they are tapped out or not. Households debt in the US increased to 78.70 percent of GDP in the fourth quarter of 2017 from 78.50 percent of GDP in the third quarter of 2017. The households debt To GDP in the US averaged 57.79 percent of GDP from 1952 until 2017, reaching an all time high of 98 percent of GDP in the first quarter of 2008 and a record low of 23.80 percent of GDP in the first quarter of 1952. The consumer, not surprisingly deleveraged after the 2008 financial crisis, however on a historical level they are still indebted well above the average. 

The Hutch Report

We won’t even bother looking at retail, as many in the financial media do, to determine the health of the consumer. An increase in Target’s earnings or any other retailer could have a myriad of reasons behind better numbers. Better revenues could be the result of taking advantage of the demise of other retailers (JC Penny or Sears for example). It could be more astute marketing or just better managed. Equally, increased earnings could come from stock buy backs, one off charges or any number of other accounting engineering tricks. 

A much better indicator reflecting the potential health of the consumer are the employment levels. These figures, particularly the unemployment rate, tells us the percentage of the labor force that is unemployed. Since unemployment insurance records relate only to people who have applied for such benefits, and since it is impractical to count every unemployed person each month, the government conducts a monthly survey called the Current Population Survey (CPS) to measure the extent of unemployment in the country. The CPS has been conducted in the United States every month since 1940. In 1994, the CPS underwent a major redesign in order to computerize the interview process as well as to obtain more comprehensive and relevant information. There are about 60,000 eligible households in the sample for this survey. This translates into approximately 110,000 individuals each month, a large sample compared to public opinion surveys, which usually cover fewer than 2,000 people. However, they are essentially polls and we have seen in the recent past how accurate polls can be. 

The chart shows a clear decline in unemployment, yet does it really tell the true story? As campaign Trump said (video below), “Don’t believe those phony numbers.”

That was an impressive speech by candidate Trump. So what do the UI numbers tell us. We took a look at the numbers from the NFP back in June (video below).

The current UI numbers are indicating a very tight labour market. Companies just can’t find the workers. However, normally when that happens a company is forced to become more competitive with other employers and increase wages in order to attract the workers they need. Yet, that doesn’t look to be happening as we see from the chart that wage growth has been pretty stagnant. 

Currently there are roughly 96 million Americans no longer in the workforce. How has that affected the poverty levels? The official poverty rate is 12.7 percent, based on the U.S. Census Bureau’s 2016 estimates. That year, an estimated 43.1 million Americans lived in poverty according to the official measure. According to supplemental poverty measure, the poverty rate was 14.0 percent. This should be considered high considering that it exists in the most affluent country in the world. 

The Hutch ReportPoverty rate in the US as a % of population – US Census Bureau

At the moment, it is not worth looking into the country’s import/export situation considering that President Trump has pulled the country into a trade war. Nobody knows how this will turn out and what the repercussions will come from it.

So in summary the charts show that US GDP growth is relatively stable, US government debt is increasing, US households savings are trending up and household debt is decreasing albeit it is still high, there is low unemployment but no wage growth and poverty is increasing. Some of the signs are a bit paradoxical such as the low wage growth which could be a partial reason why the poverty levels are increasing and consumer spending is decreasing.

So we have looked at some of the principle indicators that should provide some insight into the true health of the economy. You can take it how you see it but regardless, you have to admit that the picture is not crystal clear. Despite that, the financial media’s use of exaggerated claims such as, “Strong,” “Booming,” or “Firing on all cylinders,” gives the indication that we have entered a new era. President Trump seems to have changed his stance on the figures, touting and taking credit for the unemployment numbers that he criticized as candidate Trump. He also recently said, the US is “setting records on virtually every front” and is “probably the best our country has ever done.”

In the end, if the general public truly believe these claims, experience it in their neighbourhoods and families, they will have the confidence to go out and spend. Greater consumption patterns will improve the health of companies and they will hire. You would expect wage growth thereby lifting the standard of living across the nation. If the public does not believe the hyperbole, they will pull in their spending and try to reduce their personal debt levels. They will protect themselves.

In the end perception wins out. You be the judge.

The Hutch Report

The Debt Jubilee – “There ain’t no such thing as a free lunch”

By | Economics, Finance

It should be no surprise to anybody who has been reasonably informed about what has gone on in the last 15 or so years that debt is becoming a burden. This has become an issue not only in the US but pretty much everywhere all over the world. The debt has come in many forms such as student loan debt, credit card debt, medical debts, personal loans, and on a national scale you have the national debt, underfunded pension liabilities, medicare etc. 

The big issue is how to manage it. A few are talking about it but only in the form of a warning, “someday soon we will have to deal with it.” They keep pushing it off. However the longer you push off a problem like the one we face, the more pressing the problem becomes and that tends to eliminate the bulk of your options to deal with it when it really comes due. 

There has been a potential solution that has been bantered about for the past few years. However, it has been presented as the only solution that will be left when it becomes too late to entertain any others. The solution is known as the “Debt Jubilee,” or debt forgiveness. It means what its name implies, that if someone owes you money you just forgive the debt. The debtor is no longer required to pay back the money he/she owes.

This idea has in fact been around for a long time. Historians have counted around thirty episodes of general debt cancellations from 2400 to 1400 BC, noting they were occasions of great festivity which often involved the physical destruction of the tablets on which liabilities were recorded. One of the most famous episodes of debt forgiveness comes from ancient Babylon (modern-day Iraq). In 1792 BC, the self-proclaimed King Hammurabi of Babylon forgave all citizens’ debts owed to the government, high-ranking officials, and dignitaries (read more from our post about Hammurabi here). The Code of Hammurabi, which currently sits in the Louvre in Paris, declared:

“If any one owe a debt for a loan, and a storm prostrates the grain, or the harvest fail, or the grain does not growth for lack of water, in that year he need not give his creditor any grain, he washes his debt-tablet in water and pays no rent for this year.” 

The main thing to remember is that at that time the main creditor in most cases was the King himself, and/or institutions closely aligned with the monarch. It was relatively easy for the King to abolish debts owed directly to himself or the royal institutions, or even to a substantial proportion of wealthy creditors.

Debt forgiveness was also practiced during the time of the Old Testament. In Jewish Mosaic Law, every seventh Sabbath year saw the wiping away of all debts, where creditors cancelled all the obligations of their fellow Israelites. Every 49th year (seven Sabbath years) was the ‘Year of the Jubilee’ when freedom from all debt and servitude was proclaimed throughout the land.

This practice of debt forgiveness was not purely altruistic on the part of the creditors and ruling class. History has shown that if debtors become too enslaved to their creditors and ruling class, too disenfranchised, it opens the door for opposers or competing rulers to recruit the debtors in revolts to overthrow the ruling class. In current times, protests such as those led by the Occupy Movement show that these issues are still prevalent today and are never too far from boiling over.

At the end of World War I, Europe emerged mired in debt and in a depression. By the mid-1930s, many countries began to abandon the Gold Standard in an attempt to reflate their economies without the burden of an exchange-rate system. As part of this process, most of Europe’s governments had a significant portion of their liabilities written-off for good.

As recent as World War II the practice of debt forgiveness has been exercised. Following the end of WWII, the London Debt Agreement of 1953 saw the abolition of all of Germany’s external debt. The total forgiveness amounted to around 280% of GDP from 1947-53. This last episode is important because it is central to why a debt jubilee may not be the panacea that many believe. 

Michael Hudson highlighted why jubilee, debt cancellations, cannot now be replicated exactly:

“……the main credit/debt transactions initially were undertaken directly between the (ultimate) creditor and (ultimate) debtor. The largest credit relationship was between the government and taxpayers. Nowadays a very large proportion of all financial transactions are intermediated via financial institutions. Any attempt to cancel some category of debt, say government debt or personal mortgages, would immediately drive those financial intermediaries holding such assets, e.g. banks, pension funds, investment trusts, into insolvency.”

There are many economic and ethical problems with the debt jubilee concept. It would essentially amount to the government stealing wealth from all lenders and giving it to all borrowers. The more nefarious or corrupt you were prior to the jubilee, the more you would make out like a bandit as a result of the jubilee. A debt jubilee would paral­yse the finan­cial sec­tor by destroy­ing bank assets. In an era of secu­ri­tized finance, the own­er­ship of debt is engrained in society in the form of asset based secu­ri­ties (ABS) that gen­er­ate income streams on which a mul­ti­tude of non-bank recip­i­ents depend. Debt forgiveness would eventually destroy both the assets and the income streams of own­ers of ABSs, most of whom are inno­cent bystanders. 

As we mentioned earlier, the example of Germany’s debt foregiveness after World War II is an important one. LSE Professor of Economic History Albrecht Ritschl conducted research into how Germany was able to pay off its debts after the two World Wars:

“In a telling comparison Ritschl showed that the debts racked up by the struggling Eurozone economies – Portugal, Italy, Ireland, Greece and Spain – were equal in size to Germany’s current gross domestic product. In other words, debt cancellation for the Eurozone would be equivalent to the debts that were cancelled by the Allies after World War II.”

When polled whether or not Greece should be the recipient of some form of debt cancellation from the eurozone, only 16% of polled Germans agreed. The irony may have been lost on some.

The world’s financial system is more interconnected than ever. Debt forgiveness would take on an unimaginable complexity. There are a large number of counter-party risks as shown by the Deutsche Bank example below:

The Hutch Report

This would no longer be a one to one abolishment of debt as in the days of Hammurabi. Any debt forgiveness of one party would affect a number of other parties. As free market economist Milton Friedman once said, “There ain’t no such thing as a free lunch.” It may be time to devise another plan, and quickly.