Here's to the crazy ones, the misfits, the rebels, the troublemakers, the
round pegs in the square holes... the ones who see things differently -- they're
not fond of rules... You can quote them, disagree with them, glorify or vilify
them, but the only thing you can't do is ignore them because they change
things... they push the human race forward, and while some may see them as the
crazy ones, we see genius, because the ones who are crazy enough to think that
they can change the world, are the ones who do.

Steve Jobs
US computer engineer & industrialist (1955 - 2011)

Sunday, December 13, 2015

How bad is Newfoundland's Budget Crisis?

Newfoundland and Labrador is in the "mother of all" budgetary crisis. It is not a pretty picture. For those that don't quite get all the government lingo: a deficit is the annual loss caused by spending more than you bring in a fiscal year; the debt is the accumulation of all the money borrowed to finance those accumulated deficits over the years; operating budget is the base cost of running government operations in a year; capital budget is the cost of building facilities in a given year; and gross debt is the amount of all debt the government owes and must pay back. That's a bit of a simplification, but it does the trick.

Back when the 2015-2016 budget was crafted, the government projected $6,659,952 (billion) in operating expenses and $1,143,743 (billion) in capital expenses, for a total of  roughly $7.8 billion in expenditures. To fund those expenditures the government projected oil revenue to be $1,157,671 billion based on a base price of $62 (US) a barrel for Brent Crude. With oil at that level, the government predicted a $1 billion deficit. As a result of the recent election defeat of the government, a new deficit figure of $1.8 billion was released. In other words, the new Liberal government is saying the province has lost approximately $700 million in revenue.

The problem is things are much worse economically then they were at budget time. Oil has hovered at roughly $40-45 a barrel for most of the fiscal year, and has been trending downward (at $37.70 now). Yet, despite the collapse of the province's largest single contributor to revenues, the government has done...nothing. Here is a very illuminating example:

2013/2013 - oil revenue   $2.25 billion      Total government spending -   $7.6 billion

2015-2016 - oil revenue  $1.2 billion         Total government spending-    $7.8 billion

If that set of numbers shocks, well, it should. Now, that figure for oil revenue above was based on $62 a barrel. Just shaving off approximately 30% from that number for oil's actual prices, and we are down approximately $360 million - which leaves oil revenue for this fiscal year closer to $800 million. You have to travel back to the year 2007 to find a time when oil revenue was this low in recent history. In that year, oil was budgeted to bring in $996.5 million. The kicker is this: total budgeted spending for that year, including operating and capital, was $5.2 billion - $2.6 billion less than what is being spent today.

All of this takes on a pretty ugly picture when you consider that debt servicing charges (interest,etc on our debt) was budgeted to be $652 million this year alone. Furthermore, our combined capital and operational gross debt is now $13.9 billion. That is only $1 billion less than the perilous period of 1997-98.

So what can be done? Or, what has to be done? Both nothing and everything. The nothing portion is capital expenditures. The province can no longer afford any capital expenditures. Sound radical? Consider that capital expenditures have been in the $1.1 billion range for a few years now. That's no longer doable. That means: no new hospital for Corner Brook (or anywhere else); no new Waterford mental health facility; no new penitentiary; etc. In other words, any election promises that were related to these projects are out - they were never honest in the first place.

Raising taxes of all kinds and types will be the feature of the next budget. Sin taxes. Income taxes, Taxes on your taxes. You get the idea. However, even taxing all these areas, the government can only pray to come up with maybe $150 million, and that would mean huge personal income tax increases. After all, Ball just vetoed increasing the HST by 2%, which could have meant about $150 million for the provincial coffers. Still, that would have been a drop in the bucket for what's necessary to keep this government where its at.  Cutting civil service jobs has been ruled out by the Liberals. Salaries and benefits of provincial employees accounted for about $905 million in this year's budget. The salaries in the health sector and education sector are administered by the respective authorities. The word is they account for about 75% of the $4 billion that the province issues in grants to the authorities to run their health/education organizations.

It has to be a tempting, if not an absolute necessity, to review these employee expenses. The civil service is way too large for a province this size. The Liberals claim they will reduce it by attrition - which is a fancy way of saying once people retire they will eliminate those positions from the province's structure. Sounds great in the ideal world, but the budget crisis needs immediate heart surgery, not rehab. It can't wait that long.

Muskrat Falls is another one that must be looked at. The government has spent its part on the project already (not including over runs), so that $3 billion is gone from general revenues. However, Nalcor is holding $5 billion in investment accounts that it borrowed under the Federal Loan Guarantee. As far as I know that $5 billion hasn't been accessed yet. The province could cancel the Muskrat Falls project, work a deal with their new buddies in Ottawa to return the funds while avoiding default, and the gross debt of the province would shrink to about $8.8 billion. Such a move would dramatically improve the province's long term economic health, and perhaps forestall the otherwise inevitable credit downgrades coming our way. In addition, should Nalcor lose the current Quebec court case (now waiting for the Judge's decision as it was heard in October) Muskrat Falls annual revenue generation will drop by approximately 80% require a tripling of power bills to allow the project to break even year after year. All in all, Muskrat Falls needs to be the first victim of the financial sanity axe.

In summary, Dwight Ball is on the record as not wanting to harm the economy by instigating drastic tax hikes or mass layoffs. He's on the record as not wanting to shut down the Muskrat Falls project (he wants to "manage it better"). He's on the record for assisting iron ore companies to buy out other iron ore companies in Labrador. All these things are just pure fantasy. Complete non-sense. The truth is, bonding agencies will force the government to cut its spending - drastically. Banks will likely do the same. Newfoundland and Labrador was completely mismanaged during the years when oil revenues to the province numbered in the billions. Now, that luxury, as stupid as it was, is no longer available to politicians. Now the chickens have come home to roost. It's simple math. How bad is Newfoundland's budget crisis? It's systemic and it's catastrophic. That's how bad it is.

Thursday, December 10, 2015

On the March to World War III

As hard as it is to believe, and as hard as it is to comprehend, we are quickly moving toward World War III. It's strange in a way that the causes and signs of the impending war are wrapped like an onion - in many layers. This post is dedicated to unwrapping some of those layers, and giving people a point of reference for what's happening to their world before their very eyes.

1.  Economic Dominance equals Power.

Since the mid 1970's the US has dominated world power when it struck a deal with Saudi Arabia to have all world oil transactions conducted in US dollars. That caused currencies around the world to be valued against the US dollar rather than the previous gold standard. In recent decades the Russians and Chinese have positioned themselves to challenge Saudi's oil domination for exports and American domination in manufacturing and commerce. In 2010 the Russians and Chinese began aggressively pushing for a new world reserve currency that better reflected the strength of the world's economies (specifically the amount of debt countries carried).

After decades of  a cheap manufacturing/labour policy in China, the US had become a "fat cat" living on the glories of past economic discipline. Its national debt, much of it held by China, has come as a result of capitalism's weakest flank - the race to the bottom of the "lowest possible price". US corporations built their profits on it over the last 25 years, and the Chinese were only too happy to accommodate American corporations greed. China has now turned those profits, held in US dollars (in the trillions) into a weapon, or what is commonly referred to as the "Chinese Nuke". While maneuvering to have their Yuan installed as the world reserve currency, and thereby overtaking the US in economic and political dominance in the world, China has held the threat of mass de-dollarization , and a fire sale of US debt, over the Americans head.  In essence, the Chinese have placed the US, and the rest of the Western world in checkmate using capitalism - which is ironic considering it remains a communist country.

That leaves the Western world with two choices: 1. Accept that China and Russia have beaten them at their own game, and turn over world economic and political power; or 2. Engage China and Russia with the only possible advantage they still have - armed force.

2. Bi-Polar World

As a key part of its strategy to deny the US sole world power status, China and Russia have focused a great deal of their wealth on creating the "BRIC Alliance" or "Eurasia"(which I prefer). The core partners in this alliance are Russia, China, India and Iran. The lesser partners are Iraq, Syria, Cuba, South Africa, Argentina, and Brazil. Together they reflect the most demographically prolific regions in the world, which means they have the greatest markets to consume products, which further means that denying those markets to the West is fatal to Western trading and therefore quality of life and power. Having these regions trade together without the US dollar also necessarily relegates the US dollar to second place behind the Chines Yuan. The result is a bi-polar world. Two massive economies separated from each other - one built to grown and thrive on inter-trade and one destined to die from debt and lack of markets to support that debt.

A key developing feature of this new trading reality is military cooperation. Key to this is the gravitation of India into the Eurasian military sphere. Not only is Russia exporting its latest technology to China, India, and other Eurasian partners, but constant large scale military exercises between these countries have proliferated over the last few years. The relationships, both military and economic, now intertwine the Eurasian Community, and leave no doubt that their national interests lay with each other - not the West.

3. Might is Right.

The US is not reacting well to losing its international "top-dog" status. In fact, it has laid down the gauntlet - a bi-polar world is unacceptable. As it is incapable of attacking the Eurasian alliance financially, as to do so would immediately result in economic chaos for the West, it has chosen a military path in what can only be seen as a large scale, and very dangerous game of chicken. Notable challenges to Russia have included sponsored revolutions in Georgia, Ukraine, Syria, Iraq and to some extent former Soviet Republics on Russia's southern borders. Notable challenges to China have come in the form of economic warfare in Africa, and direct military and diplomatic measures in the South China Sea, and to a lesser extent South Korea. A large scale, but dubious economic challenge aimed at China is of course the "Trans-Pacific Partnership" (TPP) which excludes China, and is obviously intended to entice its neighbors toward the rewards of importing and trading with the American market.

Currently the epicenter of the "might will make right doctrine" is being played out in Syria, Iraq, and to a lesser extent Yemen. An escalating game of chess there is leading the "two solitudes" toward actual war. In a sense, it's a proxy war between Saudi Arabia and Iran - between Sunni and Shia. In reality, it's the purposeful use of centuries old hatreds between the two, with the goal of forcing either Eurasia or the West to accept the other's view of a "Brand New World Order". To that end, everyone is all in. Russia, despite having attempted to keep the conflict between the West and Eurasia on economic grounds (as its military is in rebuild mode with a finish date of 2020), has moved strategic and tactical forces into Syria. It has also promised to do the same for Iraq should the Iraqi government request it.

Turkey, a NATO partner, has shot down one Russian bomber, allowed ISIS forces to use its territory to conduct a "regime change war" against Syria, and now just days ago invaded Northern Iraq with a combat team of tans and infantry. According to the Iraqi government, the US has informed it that up to 90,000 Saudi troops and 10,000 US troops will be entering Iraq to "fight terrorists". In reality, both Saudi and the US have been accused of aiding, directly and/or indirectly, ISIS and other groups to overthrow the Shia governments of Iraq and Syria. Iran, the primary Shia power in the area, is already fighting in Syria, and would immediately enter Iraq, likely at the request of the Iraqi government, to fight any Saudi invasion of Iraqi territory.

In summary, it's quite easy to see where all this is leading - first the proxy powers and then the main powers. Neither side will blink. The die has been cast by both.

4. The Fall Out.

The result of the escalation we've seen is very predictable on the Middle East. Given the massive military buildup of Iranian and Saudi forces, we can expect so see a very quick and very deadly battle between the two. A battle played out from Iran to Egypt involving millions of troops, massive armour, and more importantly missile forces. While Saudi has the clear advantage in air forces, Iran has a clear advantage in missile technology to deal with them, so a land forces/ conventional war like early World War II is the likely result. In such a case, millions of fatalities can be expected. That is without the direct intervention of any super powers.

However, with Russia already in theater in Syria, and American bases scattered throughout the region, it would be naive to believe they would not be engaged. The clear advantage in such a scenario is to the Russians. Russia is closer to the area, so deployment of conventional forces there is much easier, and less fraught with intervention, than the US moving forces across the Atlantic or Pacific in large numbers. Also, in such a scenario, the US would have to deal with China on a stand alone basis in the Pacific area. Not an easy task considering China's conventional and strategic forces.

Then there is the "home front factor". In such a scenario Western Europe is bound to be drawn in immediately against Russia. It is very, very doubtful that western civilian populations have any stomach for war against the Russian people - no matter the sell to support it. Having lost untold millions in recent memory to large scale war, and the destruction of their countries, most Europeans are likely to rise up against such a proposition. Equally volatile is the American population. Notoriously inward looking, most Americans are consumed with their own country and have no stomach for foreign wars or any kind that involve casualties - let alone a war that would cause mass casualties in the US itself.

So, while the powers to be in the West maneuver toward world war, it is highly doubtful the population would support such an action. Conversely, the Chinese in particular have no such issues. The financial collapse of 2008 required 200 million Chines be sent back to their villages from urban centres in China, without so much as a peep. Such an action in the Western world would have resulted in revolt. So, that is the playing field. In all scenarios, the West can not win the battle it is formulating. It is unlikely that anyone would win from such a war, but it is certain that if there would be a victor that it will not be the US or the West.

5. What Should Happen.

In the ideal world, which could be this one, the West ought to admit economic defeat and take its place in a new bi-polar world. The rules of the game were set by the West, and the loss of that game ought to be accepted by the West. To change the rules to suit your own purpose simply destroys not just your credibility, but also that of the "world system" itself. History has ebbs and flows. Empires rise and fall. Economic systems collapse and are rebuilt. We know all of this from a simple study of our own recent history. It is the nature of the beast. To fight that result as if somehow your empire is more noble than any other of the past is arrogance beyond the pale.

The rationing of whatever resources the world has that we feel the need to consume has always been dictated by the efficient production and consumption of those resources - whatever the system. If the Chinese, Russian, Indian, etc countries are now in a stronger position to carry forward with that leadership in consumption, well, that's just natural selection really. They've shown discipline in consumption while we have not.

In the end, the only way to avoid what is playing itself out now in the world, the US and the West in general needs to accept that the Eurasian countries have worked their way up to likely dominate world trade and to some extent power. Perhaps it is a chance for all of us to renegotiate, or rediscover, the respect for sovereign nations and people that has been woefully discarded. Would that not make for a much better world for all of us? I believe it would. We don't need a Walmart to survive or be fulfilled.We do however need this planet.  


Tuesday, December 8, 2015

The Newfoundland Nightmare

Newfoundland's economic problems are all structural, and now those problems are all coming home to roost. The structural part is not new. In fact, they trace back to the "merchant" days here - which in many ways have not changed. A small group of select families have controlled everything from insurance to resources, and everything in between for centuries here. Looking through that prism it is easy to see "modern" Newfoundland and Labrador's key structural problems.

Everything that is worth anything is controlled privately. Now, pure economists or extreme capitalists will argue that isn't a structural problem, but rather the way it ought to be. However, a province with such a small population must have a revenue stream greater than more populated provinces in order to adequately support its operations. In Newfoundland's case, successive governments have sold that revenue generating capacity away. The province is at the point where its major streams of Crown corporation revenue, other than oil royalties, rests really in liquor and gaming, and to some extent Nalcor Energy/NL Hydro.

It is quite easy to see why NL Hydro and Nalcor are still in government hands. Firstly, NL Hydro is not a money maker. Its primary function is to generate power - not retail it (where the money is). In other words, taxpayers pay for the generation of power, and NL Power (Fortis Corp) sell the power at retail prices while avoiding the costly problem of infrastructure to produce it. It's a win-win for NL Power, and a lose-lose for the average citizen.

Another industry which should be nationalized, or never privatized as it was, includes the insurance industry. The provincial government sees almost nothing of the car insurance, house insurance industry revenues that regenerate annually.

Telecommunications is another example. There is no provincial phone/cable company that could generate annualized revenue for provincial coffers.

Now all this may sound a little socialist in its undertones, but the bottom line is all the worth while wealth of the province has been transferred from the public's hands. That means there is not sufficient cash flow returning to the provincial coffers to adequately fund a modern quality of life. This becomes glaringly obvious when the one gravy train,oil, falls on its face. That is exactly where we are at today, and where we keep finding ourselves in the future. Structurally there can be no other result.

However, it isn't just the "little" people that get hurt in this cannibalistic economy. Small and medium sized businesses, municipal governments, non-governmental actors, and even the provincial government suffer as well. Eventually the loss of revenue from the local economy results in: less consumption of goods and services; higher government taxes; and uneven business cycles. That makes economic activity and necessary governmental wealth unstable and inadequate. And all that combined puts Newfoundland and Labrador's economic and social existence on thin ice - which in turn results in out migration, which in turn makes the core problems even worse.

Eventually all this must come to a head and fail. I believe we are almost at this point now. With an accumulated deficit now reaching almost 9 billion dollars, and structural budget deficits of at least a billion dollars a year for the foreseeable future, there is no answer for this province's nightmare. Raising taxes further will kill whatever consumption economy is left here, while failing to do so will kill governmental activity. Cutting civil service jobs may make governmental activity somewhat more efficient, but it will also severely damage the one "stable" economic driver for consumption. In short, the economic elites in the province have managed to paint all of us into the proverbial corner. There are no immediate solutions left. Nationalization of key industries like power, cable and insurance would provide some long term stability, but would require putting out money now that the province doesn't have. All in all it's a nightmare - a Newfoundland nightmare to be sure.