Category Archives: Original Articles

After Brexit, Who’s Next?

After the surprising result of Brexit, there are more and more doubts about the feasibility and efficiency of Eurozone system. Brexit uncovered major concerns, such as the European single market’s lagging global trading competitiveness, immigration issues, risks on unitary regulations and laws. This event triggered the alarm for Eurozone countries to reconsider whether it is beneficial to stay in Eurozone.

Let’s take a close look at the actual economic changes to those Eurozone countries to judge which countries are better off within the Eurozone, and which are worse off. We build an Economic Scorecard Model (final data as below) based on 20 years of data from 1997 to 2016. The seven economic indicators used are real GDP, unemployment rate, inflation rate, government debt, industrial production, retail sales index, and trade balance. Based on the characteristics of each economic indicator, we have analyzed each variable from absolute and relative levels.

Ireland is the best-performing country in Eurozone with an overall score of 69.51. Ireland aces real GDP and unemployment rate metrics and ranks second for industrial production. Belgium, Malta, Germany, and Finland rank from second to fifth place with scores of 62.59, 57.32, 55.79, and 55.6. Looking at the bottom of the rank. Slovakia, Cyprus, Greece, and Portugal have overall scores below 40. Unsurprisingly, Greece only has an overall score of 32.04 with worst performances in real GDP and industrial production metrics. The Economist would agree with our model when they state, “As it turned out, the super-responsible ECB spent the 2000s making a monetary policy that fit the laggardly German economy, and which was actually too loose for Greece’s economic situation” [1]. Portugal has an extremely low score of 19.57with zeros and single-digit scores for five factors out of seven.

Now, on to the more dominant countries. Germany, as the largest manufacturing and exporting country in Europe, has the highest world rank at 4th place with a score of 55.79. Eurozone brings plenty of benefits to Germany, and as Fortune would put it, “Germany’s gains in competitiveness were immediately translated to gains in trade, since the freedom of goods, services, persons and capital allowed German products to circulate freely and quickly throughout the European Union” [2].  The Euro helps Germany offset the effect of booming export on currency appreciation. Their ability to keep good prices competitive relative to other European markets gives them huge advantages on foreign trade. It scores 100 on trade balance metric and leads the second-place Ireland by 55.54 points. Inflation stability and improved unemployment also support Germany in developing further under the Eurozone system.

France is the worst performer among major Eurozone countries. Unemployment score is the only other score above 50, while the scores in all other metrics are depressed, which show the country suffered from low real GDP growth, increasing government debt, deteriorating industrial production, and decreasing the foreign trade balance. No wonder populism is booming in France. Eurozone system does not seem like a good fit for France. Even though Macron won the presidential election, Le pen’s National Front could grow further in the future if the fundamentals in France don’t change.

Italy scores 42.9 and is one place above France in the rank. As a well-developed country before joining Eurozone, there was not as much potential to improve on retail sales and the unemployment rate. Real GDP growth is the second worst among Eurozone countries with a score of 1.68, and even trade balances got worse. Further, industrial production has completely collapsed under the euro — it has been absolutely butchered – since, after entering the single currency market, Italian firms can no longer offset their high production cost by depreciating their currency. This has been deteriorating their trading competitiveness dramatically and has led to the slowdown of a historically great economy. Facing corruption, fiscal and banking sector issues, and a refugee crisis, it is time for Italy to change. The Anti-Euro Five Star movement is leading the poll at 32%, whereas the center-left Democratic Party is at 26% [3]. It is very likely that the Five Star movement will win the election next year and exit the single currency market soon thereafter.

The creation of Eurozone has its own benefits and flaws. It is crucial to question whether Eurozone is a good deal for all the Eurozone countries. Based on the Economic Scorecard model, the answer is simply ‘No’. Just as Nobel laureate Milton Friedman (1997) wrote: “Europe’s common market exemplifies a situation that is unfavorable to a common currency. It is composed of separate nations, whose residents speak different languages, have different customs and have far greater loyalty and attachment to their own country than to the common market or to the idea of ‘Europe’ [4].” With more exposure of the innate problems of the Eurozone system, the European right-wing is gaining popularity. Structural changes to reshape the Eurozone are unavoidable.

After Brexit, who’s next? My answer is Italy.

 

Citations:

[1] http://www.economist.com/blogs/freeexchange/2011/07/greece-and-euro

[2] http://fortune.com/2014/10/22/why-germany-is-the-eurozones-biggest-free-rider/

[3] https://www.ft.com/content/ff14351c-3572-11e7-99bd-13beb0903fa3

[4] https://www.project-syndicate.org/commentary/the-euro–monetary-unity-to-political-disunity

 

India’s Attempt at Becoming Cashless

Do you remember when Canada got rid of the penny? There was months of advertising, plenty of time for planning, and thus it was relatively easy to exchange pennies for other forms of money. But many people didn’t bother exchanging, as Canada’s economy is not exactly dependent on the penny, and most people in Canada don’t use cash for transactions regularly anyway [1].

Now imagine if 78% of transactions in the country were done in cash. And then one day, without warning, the government got rid of the most used bank note in the country – say the $20 bill. Imagine the chaos that would ensue. That is what happened in India.

On November 8, 2016, Prime Minister Narendra Modi announced he would be getting rid of the old 500 and 1000 rupee bank notes, and issuing new 500 and 2000 rupee bank notes. The deadline for the exchange was December 30, 2016. In addition, people could only exchange a certain amount of money per week. Finally, large exchanges – over $3600 – were subject to a tax.

The reason for PM Modi’s decision was to tackle crime and corruption in the country. It is easy to see why cash transaction would be so helpful for different kinds of criminals. It is extremely hard to track. This leads to huge amounts of tax evasion and an easier time for underground criminals.

In a month and a half, roughly USD 183 billion dollars were exchanged. The process, was unsurprisingly rough. Since the decision was such a surprise to everyone, people had to line up for hours. As well as that, there was an initial shortage of new banknotes, and people living in small villages had a hard time even getting to banks. Many Indians didn’t even have a bank account. This was an unmitigated logistical mess – especially early in the transition.

Because Modi decided to get rid of about 86% of all currency in circulation, there was a tremendous shortage of cash – in a country that runs on cash!. This is causing a slowdown in the Indian economy. Investment, real estate, and the automobile industry are all down. And perhaps most devastatingly, farming is down, too [2].

The slowdown hurts the poorest Indians the most. Those living on the edge of poverty, now have to reduce consumption. This might be okay in a developed country, like Canada, where incurring a slowdown may help to solve such a problem. But for those on the poverty line, a reduction in consumption means eating less food [3].

The question remains, what about the corruption that was going to be combated? Well, the evidence on that question has yet to come in. There is, of course, the fundamental question, what is stopping criminals from switching over to the new cash system – especially when more cash becomes available? It is true that more tax than usual was paid over the last two months, but beyond that, this policy won’t shift India into using plastics overnight. Overall, expert opinion seems to say that crime will not be too affected by this new policy.

The dream of Modi, to turn India into a cashless society and to combat crime and corruption, is worth striving for – considering the level of tax evasion. But an aggressive policy like this targeted toward an India that is simply not ready to become cashless is a misguided move that will continue to have harsh economic consequences.

[1] http://www.bankofcanada.ca/wp-content/uploads/2015/05/boc-review-spring15-fung.pdf
[2] http://www.npr.org/2017/01/03/507983996/indian-farmers-hit-hard-by-governments-currency-restrictions
[3] https://www.nytimes.com/2017/01/02/world/asia/modi-cash-ban-india.html
[4] http://blogs.wsj.com/briefly/2016/12/30/50-days-of-indias-war-on-cash-the-numbers/
[5] https://www.bloombergquint.com/business/2016/12/30/50-days-after-demonetisation-real-estate-deals-remain-few-and-far-between
[6] http://www.livemint.com/Industry/SIK34NIedgYQjLwFHmy6BI/Demonetisation-takes-a-toll-on-automobile-sales-in-December.html
[7] http://www.livemint.com/Politics/5vmA6lF40HFY3P381uzkTJ/Demonetisation-takes-toll-on-investment-manufacturing.html

Record-Breaking IPO: Saudi Oil Giant Aramco Going Public

Since 1945, the world has seen an era of American leadership. Now, with the populist mindset swaying in favor of protectionist policies and the 2008 Financial Crisis still reverberating in the pockets of the public, a new stage has been set with the receding role of the US in international leadership. Reminiscent of, though not entirely resembling, the American isolationist period of the 1930s, this power vacuum will grow and peak in 2018, when the full impact of the Congressional budget comes into play. The fair question: which actors will fill this vacuum, and with what currency?

Percent change of budget, based on the Trump Administration’s preliminary 2018 proposal // The Washington Post [1]

Enter Saudi Aramco, a private oil company that currently supplies one out of every nine barrels of oil produced in the world [2]. Founded by the Standard Oil Company of California, now Chevron, in 1933, shares were completely bought out by the government of Saudi Arabia by 1980 [3]. Whilst contributing up to nine-tenths of Saudi revenues [4], the global perception of climate change and the subsequent push for renewable, non-oil, energy resources has prompted Saudi Arabia to propose a hard-turn diversification program – Vision2030 [2]. The plan begins with the Initial Public Offering (IPO) of up to 5% of Aramco stake by late 2018, with a predicted price at $100 billion [3], trumping Alibaba Group’s record-bearing offering of $25 billion in 2014 [5].

 

Comparison of Aramco’s potential offer to previous offerings // Bloomberg [5]

The Saudi Arabian government has stated that the valuation of the company will by $2 trillion on the public market [2], but other estimates, like that of Wood Mackenzie Ltd., come up with a valuation of $400 billion [5]. However, these lower bound estimates are based on the current financial structure of the company, and with JPMorgan working with the Saudi authorities on broad changes in regards to regulatory exposure, disclosure rules, dividend policy and exchange listing options, this valuation estimate is likely to be higher [2].

Further, the Saudi government’s financial restructuring and other initiatives in line with Vision2030 will be the greatest factors of success before this momentous listing. One such government scheme is the Citizen’s Account, which will dole out $6.7 billion worth of public disbursements in 2017, increasing to almost $20 billion by 2020, in order to limit the influence of energy price increase on citizens and subsequently soften the effect of austerity measures. Additionally, a new excise tax on ‘harmful products’, like tobacco and energy drinks, will begin, along with a 5% value-added tax in 2018 [6]. As well as that, there have been talks to review Aramco’s income tax rate from 85% to as low as 50% [7]. Further, the biannual reduction of fuel, water and electricity subsidies that started in 2015 will continue. Moreover, to counter the current slowdown, considering the 3.4% to 1.1% growth from 2015 to 2016 and an expectant growth of 0.9% in 2017, a stimulus package of almost $60 billion will be allotted until 2020 [6].

Along with the dynamic attitude of the Saudi government, Aramco’s own restructuring and diversification projects are underway. Advisors and company executives are discussing whether to make Aramco a ‘global industrial conglomerate’ or a ‘specialized international oil company’. Leaning towards the former, Saudi officials are considering the reformation into something reminiscent of a ‘Korean chaebol’, a reference to South Korean family-owned conglomerates, thus expanding the company’s role in petrochemicals and other sectors. As Aramco begins to diversify, with a $5 billion ship repair and construction complex on the East coast, $400 billion forging and casting projects with General Electric and plans to build solar and wind power facilities, the risks of investment become more diverse and the company gets harder to value [7]. However, the synchronization of company and government initiatives, as enabled by Deputy Crown Prince Mohammad bin Salman Al Saud, doubling as the owner of Aramco and chairman of the Council for Economic and Development Affairs, will result in the growth and valuation of the company at a much higher level than some anticipate.

Even when withholding the effects of diversification, Aramco is still expanding its natural gas production capacity, and wants to double it from 12 billion to 24 billion cubic feet per over the next 10 years [8]. And given that the oil market will continue to perform well, as it has done since the production cut in November 2016 when OPEC reached an output agreement [5], Aramco’s success in this sector seems inevitable.

OPEC Performance after the production cuts // Bloomberg [5]

With the ambitious objective to create a sovereign wealth fund that will anchor Saudi state revenue by 2030, there’s no doubt this IPO will have a monumental impact on the cash flows of the East. A survey conducted by investment bank EFG Hermes at an investment conference in Dubai, polling 510 international fund managers, shows that 63% predict Aramco’s market capitalization to be over $1 trillion, while 36% predict under $1 trillion [9]. Such a valuation falls in the middle, though leans upward, between Saudi Arabia’s prediction and Wood Mackenzie Ltd.’s harsher rough valuation of $400 billion. 

Comparison of the valuation of publicly traded companies, highlighting Aramco’s potential // Bloomberg [10]

If the valuation were to reach the upper bound, Aramco could swallow Apple twice and still have enough room for Google’s parent, Alphabet. On the lower bound, the company would still shake up and redistribute markets and begin its capitalist conquest through mergers, acquisitions, investments at an entrance point just above Facebook. With a 5% float of the company, the number of shares of Aramco available for trading, the company is estimated to account for 2.4% of the MSCI Emerging Markets Index’s gauge. This would thrust Aramco into the top five, alongside Samsung and Alibaba, and inflows to the Saudi Arabian foreign money market are expected to be at $6.6 billion from MSCI trackers and $2.5 billion from FTSE investors [5].
However, the Tawadul, Saudi Arabia’s Stock Exchange, has a market cap of only $440 billion, and so Aramco will seek out another Exchange, or multiple others, to list itself on. Preference is for a listing in the NYSE, despite a Congressional law being passed in 2016 that could allow American terror victims to sue Saudi Arabia. This, along with Trump’s islamophobic rhetoric, has potential to derail a NYSE listing [11], or elicit partial listings in multiple Exchanges, in which case the London, Toronto, Singapore and Hong Kong Exchanges are other stated options [5]. Regardless of the listing location, as trade barriers go up in Europe and the US enters an era of isolationism, Chinese and OPEC influence will rise and their bond will create the foundations of this global power shift.

 

References

[1] https://www.washingtonpost.com/graphics/politics/trump-presidential-budget-2018-proposal/?utm_term=.7483d7263da8
[2] https://www.ft.com/content/99353918-ed8c-11e6-930f-061b01e23655
[3] https://www.forbes.com/sites/ellenrwald/2017/02/25/the-worlds-biggest-ipo-is-coming-what-you-should-know-about-aramco/#29110053535f
[4] http://knowledge.wharton.upenn.edu/article/boutique-firm-landed-big-role-aramco-ipo/
[5] https://www.bloomberg.com/news/articles/2017-02-26/this-is-all-the-ways-a-saudi-aramco-ipo-could-impact-markets
[6] https://www.bloomberg.com/news/articles/2017-03-06/aramco-ipo-prep-on-powerful-saudi-prince-s-long-2017-to-do-list
[7] http://www.reuters.com/article/us-saudiaramco-ipo-restructuring-idUSKBN15W1ZB
[8] https://www.bloomberg.com/news/articles/2016-10-06/saudi-aramco-ipo-will-offer-stake-in-all-of-company-s-operations
[9] http://uk.businessinsider.com/investors-expect-saudi-aramco-ipo-to-value-at-one-trillion-2017-3
[10] https://www.bloomberg.com/news/articles/2017-02-23/saudi-arabia-2-trillion-aramco-vision-runs-into-market-reality
[11] http://www.marketwatch.com/story/saudi-arabia-favors-new-york-for-aramco-ipo-2017-02-21

Pros and Cons of Paperless Money

Money as we all know is an important unit of account and an essential tool for trade. Recently, there has been great speculation on the benefits of going paperless once and for all. Currency has been the fundamental pillar in our monetary system and has given rise to trade and investment. The reason why speculations regarding going paperless is more prominent than ever is due to the fact that we live in a virtual society. Money is often sorted through intermediaries and many trades and investments are made without actually physically seeing any coins or bills exchanged. What are the benefits of completely digitizing currency and what are the costs of abandoning our existing system?

Stimulating the Economy and Negative Interest Rates

One key reason for the removal of physical currency is the incentive that if all money is held in financial institutions then people would be forced to invest their money. Currently, people are simply able to withdraw any amount of money they possess and take it out of circulation by keeping it in their homes. The purpose of financial institutions is to bring people who have money but no time to create businesses and connect them with people with spare time and capabilities to create businesses but lack liquid capital. By withdrawing the money it is removed from circulation and a central function of banks is rendered useless. It has been proven that people would rather hold cash in their closet than place it in assets such as bank CDs and treasury bills offering 3-5% interest. [1] Harbouring money keeps it from being utilized for investments and has some effect in impeding the economic expansion.

Due to slow growth of the Canadian economy many are looking at alternative ways to stimulate expansion. In recent years there has been some success in European countries with negative interest rates. In Switzerland there exists 30 year bonds that offer negative interest rates directly contending the Swiss franc with the euro system in place. It is highly difficult to push interest rates into negative areas as vast amounts of cash are hard to maintain. Moving to a cashless economy could allow central banks more flexibility to push the interest rates as negative as preferred to induce an expansionary monetary policy during a recession or depression. Negative interest rates are difficult to achieve and require much more than simply going paperless but would give governing institutions the help they need in times of financial crisis.

Bypassing Hidden Costs

Another reason for why keeping cash is a burden is the existence of hidden costs. There are many costs associated with possessing physical money including the cost of maintaining the currency itself. Printing, minting, and redesigning currency are all costly projects funded by the government through tax payer dollars. The Bureau of Engraving and Printing produces 38 million notes a day with a face value of approximately $541 million USD. Although $541 million is printed 95% of that amount goes to replacing notes already in circulation. Adopting electronic processes saves the environment because it would make use of virtual currency that do not have a physical denominations. The elimination of cash also forces the discontinuation of paper receipts and reports which are frequently mailed. The cost of sending a receipt or replacing a financial document can waste time and resources. The accessibility of physical currency accounts for a minority of transactions and only 14% of exchange is done with paper  in US. [2] Eliminating that 14% can drastically benefit the US economy and allow them to focus on reforming the financial system for the 21st century.

Difficult for Illicit Activities

The elimination of cash would discourage people from illicit activities. It would be difficult for someone to transport a large quantity of money without being detected. Currently, transporting millions of dollars is an easy task. We have seen it in movies where a villain easily carries a briefcase filled with cash to a drop off location. If cash is eliminated then criminals would have difficulty transporting money and completing illicit transactions. If crime money is stored in banks it would leave a clear financial trail which is easily detectable. Eliminating cash also helps with preventing street crime. Thieves would have less initiative to rob people knowing that they would not be carrying cash. A study from Missouri during its mid 1990s transition with welfare benefits suggested that going from a cashable cheque to a debit card allowed the crime rate to drop roughly 10%. [2]

Drawback of Eliminating Cash

With all these positive features of a virtual currency why has it not been implemented?The one benefit of holding cash is anonymity, cash is nameless and offers no history of transactions. It allows people to make purchases that cannot be traced and is an essential freedom to our private lives. Hoarding cash also allows people with massive amounts of wealth to fool tax organizations or even family members. By going digital we are forgoing our right to private transactions. The concern is where the line on personal privacy lies and at what point is it no longer acceptable for a third party to have information on our daily lives. If cash is eliminated this would grant government entities who upkeep their respective currencies unlimited power to manipulate currencies. The existence of cash keeps government power in check and creates a buffer for monetary policy using natural market mechanisms.
Cash is an important part of any economy and serves an essential function in our everyday lives. Having physical currency is important and cannot be ignored when contemplating the future of the global economy. However, it is important to recognize the issues with our monetary system as it is. Money works best in an economy when it is treated as a hot potato, allowing it to circulate instead of it being idle.

References

[1] http://www.rcwfinancial.com/cashless-society
[2] http://time.com/money/4307717/getting-rid-of-cash/

Tax Evasion in Canada’s Sharing Economy

Canada’s sharing economy is booming. According to Statistics Canada, almost 3 million Canadians spent over CAD 1.3 billion participated in the sharing economy [1]. Companies like Uber and Airbnb are revolutionizing their respective industries. And with Uber set to enter into British Columbia by the end of this year [2], the impact of the sharing economy will only grow.

However, there is a major problem that tax collectors are starting to find – Canadians aren’t reporting income generated from the sharing economy. According to an article from the CBC, the misconception occurs because many people are new to self-employment[3].

Uber has solved the problem for sales taxes, though. Since it doesn’t add in the cost of taxes to the amount the rider pays, what Uber does is take the money straight from the consumer to Uber itself, and then pays the rider with taxes deducted. So, essentially the driver is getting paid less than what the consumer pays. Unfortunately, this isn’t as simple to do with income tax, as it is far more complex than sales taxes.

To counter some of these problems Airbnb is sending out reminder emails letting  hosts know to declare their income. Meanwhile, Uber and Airbnb both are partnering with different tax preparing companies, like TurboTax and H&R Block, to help their users get the taxes right [4].

As the sharing economy continues to explode, it will be interesting to see how tax collectors respond, to ensure tax evasion doesn’t continue to grow with it. Thus far it still largely remains an underground sharing economy unknown to tax authorities.

 

References

[1] http://www.cbc.ca/news/business/statistics-canada-sharing-economy-1.4004993
[2] http://www.huffingtonpost.ca/2017/03/07/bc-taxi-industry-uber_n_15223560.html
[3] http://www.cbc.ca/news/business/taxes/tax-time-2016-uber-drivers-1.3462006
[4]http://globalnews.ca/news/3305907/canadians-in-the-sharing-economy-are-running-out-of-excuses-not-to-pay-taxes/

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