Small Town Economics

I’ve spent some time in both Gisborne and Blenheim recently. One thing you notice is that in smaller towns, there are a lot of big chains. I was thinking about why this is, and have a theory that goes something like this:

Because margins in retail have become quite thin, even long supply lines (distance from distribution centre to a node in a retail network) can be economic and profitable when these processes are highly productive.

The local retailer does not have buying power – they can’t negotiate directly with the manufacturer, they can’t get good freight deals because the volume of their freight is far lower than a national chain – the economies of scale are enormous when you add them up across all of the inputs for a basic retail store, particularly when you think about technology and point of sale efficiencies.

And that’s before you think about wages – stories in the US suggest that big chains pay better than “mom and pop” stores. What is a riskier employment proposition – a small store or a national chain that might even offer management training and higher wages over time?

The only hope for smaller retail stores is to have very streamlined and flexible lines of business. Selling higher margin products helps, but easy online shopping, returns and customisations and smart marketing are the only way to stand out from the crowd.

3 stories of winner take all markets and average is over

NBC News suspending Brian Williams without pay for 6 months and the new figures for Premier League television rights up 70% for the next 3 years.

The Premier League rights will cost £5.1 billion for the next 3 years. Most clubs lose money hand over fist and a few star players and managers accrue most of the rents from the money sloshing around from television rights and merchandising.

Calls to cut ticket prices for “real fans” will be met with deaf ears because of 1) revealed preferences for football fans to spend a fortune 2) the enormous sums that can be charged to corporates for hospitality at Premier League games.

Nightly News makes US$30 million in profit a year while paying Mr Williams over US$10 million in salary. A 30 second ad spot is over US$50,000 according to some stories I’ve seen.

And then there is this story at Fusion about income inequality within the (US) millennial demographic. The 1% starts at US$129,000 per annum.

Millennials with bachelor’s degrees have the greatest share of their generation’s One Percent, at 39 percent, compared with just 7 percent for individuals who only graduated high school and 10 percent for college dropouts. And 76 percent of millennial one percenters have at least a bachelor’s degree — yet more evidence that it pays to stay in school, if you can get there.

The college premium for graduates of quality colleges with majors in demand in the labour market are doing just fine. All of this is very interesting. If you look at NZ Census figures, there are a non-trivial number of millennials who aren’t part of the lost generation.

 

What is this “club” you speak of?

British Foreign Secretary rocks up to Wellington and says New Zealand is “part of the family”, thus we need to make a contribution of 100 soldiers to an Australian operation that already has a few hundred soldiers and pilots in the Middle East.

Apparently, helping to train the Iraqi military and build it back up again isn’t going back into Iraq. What an abuse of the English language. The idea surely was that all of those resources poured into the Iraqi military – training, equipment, technology and embedded advisers – was supposed to help them get on their own two feet to fight ISIL?

The consequences of political actors’ need to be needed by the international community are grave. There is no clear strategic interest for New Zealand and no clear strategic benefit that we would obtain. The Iraqi government is likely to collapse – this situation is far too complex for any New Zealand military planner to wrap their heads around, far too volatile for any New Zealand diplomat to be able to be helpful in the event of a soldier getting kidnapped by ISIL and far too far fetched to be a credible use of the NZDF.

How about sorting out whaling ships and vessels that fish illegally in our EEZ first, before doubling down on foreign entanglements? We’ve had UN Observers in the Middle East for decades, what has that achieved in terms of concrete gains in the situation for the locals? Is expending resources purely for the sake of being seen to be participating in what “the family” is doing really the basis of sound foreign policy?

Slimmer RMA won’t improve affordability

I’m not convinced that reforms to the RMA will lead to any improvement in housing affordability. Much like work expands to fill the time available, house size and features expand to fill the budget available.

When banks look at houses as the premier security for all lending, even if you have a solid business generating free cash flow, whatever cost reductions in house construction can be achieved are likely to be immediately consumed in the form of bigger kitchens, more media rooms and larger garages.

State houses were 60 square metres back in the day, the average house size is more than 200 square metres now, and there is a strong cultural preference in New Zealand for housing arrangements that don’t work in a city with the geography of Auckland – water everywhere gets in the way!

In The House of Debt, US research shows a marginal propensity to consume gains in housing value between 0.1 and 0.4! The surge in retail spending last year on the back of house price gains in Auckland isn’t surprising. How many people are being prudent are using higher house prices to reduce their debt and build actual wealth? Not many, if any.

92% of household net worth in New Zealand is tied up in home equity. No one can afford the capital losses that housing affordability policies would actually produce. Witness the fury over attempted changes at school zones – that’s nothing compared with how people will mobilise to protect their rents from choosing to purchase a Ponsonby villa in 1970 and never selling.

Many households also don’t have mortgages – if they sell at the peak and downsize then that’s a permanent reset of their lifetime consumption possibilities. Selling in Auckland and retiring elsewhere is one reason why it mightn’t be too big a deal that home ownership is slipping in Auckland. Maybe more young people are realising they might need to buy their retirement home in a cheaper provincial city first?

Central bank credibility

An interesting comment has been made around the financial news sites and blogs since the Swiss National Bank decided to abandon the 1.20 EURCHF peg on Thursday.

It’s that the Swiss National Bank has somehow damaged their credibility by abandoning the peg and thus market participants lost a fortune on Thursday. Some FX dealers that let their clients trade with high leverage needed to raise additional capital to meet regulatory requirements and open on Friday.

If anything, the Swiss National Bank has proved the power of central banks is limited and that they are very credible because if they weren’t credible then no one would have lost money on Thursday. But they had given guidance that they’d keep the peg against the Euro for some time.

There hasn’t been any discussion of the net winners in the money market on Thursday. When the European Central Bank starts up quantitative easing then the Euro will weaken further and some of the mark-to-market losses the SNB has incurred will be recovered.

For other market participants, this is a lesson that trying to intervene in the foreign exchange market to protect your currency from becoming too valuable or too undervalued is a fool’s errand. A central bank with a balance sheet equal to 85% of GDP is basically a sovereign hedge fund up against the global financial markets.

In terms of what impact this will have on Switzerland itself, higher spreads are a likely result. This will suck for CHF denominated loans that need to be rolled over and Swiss firms or foreign firms looking to rollover or reissue CHF denominated bonds.

There is another lesson about risk and leverage. Retail investors have no business trading FX with leverage of 50:1 when the largest FX desks at the biggest banks in London, New York and Tokyo probably wrote off $1 billion on Thursday. I don’t understand what could compel people to think they have an edge here, when clearly almost all market participants were surprised and the spot market for CHF dried up meaning people couldn’t liquidate positions.

Debt and Wealth Inequality

Initial endowments matter. I’m reading House of Debt and enjoy the points made early in the book about how the poorest households lose the most when they take on leverage they can’t afford.

When house prices fall 30% and you have a 20% deposit you are exposed completely to house prices. You are now a mortgagee sale statistic in New Zealand with a disproportionate amount of negative consequences that entails relative to the United States where in most states you can simply hand the keys back to the bank and have the property go into foreclosure.

My main concern with households that use Kiwisaver to top up their house deposit is that they generally stop contributing to Kiwisaver and thus have no diversification outside of New Zealand home equity. In the next recession, this will suck for them because unless they’ve made significant headway in reducing the principal of their mortgage, their household’s balance sheet and income statement will be a sea of red.

Just because almost everyone thinks that something is a good idea, particularly around the holiday season, for young couples to enter into highly leveraged housing services contracts with a high level of spending reset attached (maintenance, lawnmower service, sum insured valuation etcetera) doesn’t mean that it’s a good idea and in fact probably means it is batshit insane!

A lot of young people need to slow down and realise that rushing into major contractual agreements before their household’s balance sheet can take on that risk is extremely risky. If you look at the finance literature, the empirical evidence is quite clear – high capital returns in the recent past are the best predictor of low future capital returns in the near future. Mean reversion isn’t just an academic turn of phrase.

Reinsurance rates dropping?

It would be cool if New Zealand journalists did their job and worked through this sort of information (FT registration needed) to things like “sum insured” that affect New Zealand policy holders. Infographics are in, aren’t they?

In the aftermath of Christchurch, it astounds me at the lack of detailed investigative or advocacy journalism into the structure of the insurance industry. Some journalists have gotten close and written excellent stuff, but still no cigar.

The narrative doesn’t really have time for detailed market microstructure discussions that are essential for building a base of knowledge with which to think about the long term policies that might be required to address any market failures seen or thought to be seen.

 

Statistically Ignorant People Freak Out About Plane Crashes…Yet Again

Statistic Brain bust out the data that shows a 1 in 29.4 million chance of dying on a single airline flight. There are other numbers I’ve seen, like 1 in 11 million and 1 in 13 million but overall, given the enormous number of aircraft movements every single day around the world, only people ignorant of statistics and probability will be freaking out over airline travel.

This is a direct link to other instances of ignoramus behaviour – like counting all of the “social costs” of something “bad” without calculating the benefits that accrue to the individuals who choose to undertake a “risky” activity.

There’s nothing you can do to manage these sorts of tail risks other than not engage in the activity – which is stupid – so worry about things that you can actually control and get on with your life. The funny thing is that you can quickly Google search likelihood of dying in a plane crash and figure this out for yourself, but that’s not sensationalist news coverage and most people are very reactive to anything that happens that is brought to their attention via television news or social media – they lose any semblance of rational thought they may have possessed.

TARP turns a profit?

Over at Vox, there’s a nice post on how TARP has turned allegedly turned a profit. But when I went over to the US Treasury website Troubled Asset Relief Program page, and read through some of the reports they’ve produced on the matter, I’m not sure that Vox is being clear enough here about what those figures actually mean when you start thinking about how this money was mainly disbursed in 2008 and 2009, but has been repaid over time.

Claiming to have made a trivial profit relative to the enormous amount of capital deployed into an industry that lost a lot of money on bad investments isn’t prudent. $15 billion / $426 billion over 5 years is a lower return for the US Treasury than buying their own product (bills, bonds, notes) and holding them on their own balance sheet as Treasury stock.

For all of the time that this capital was deployed recapitalising failed firms and acting as a vehicle for stimulus, there was some next best alternative foregone. For example, upgrading long deferred infrastructure upgrades and maintenance in the US could have provided substantial fiscal stimulus and achieved many of the things that TARP boosters claim to have aided in ensuring like a really slow, grinding recovery from the GFC.

But that’s not what happened, and the economic literature is quite clear that the long term impact of graduating into a recession permanently lowers lifetime earnings for college graduates. When you add in the growing level of under-employment and frustration around the distribution of opportunities in the economy, the past few years have spawned a non-trivial number of 20-30 year olds who are absolutely furious about how things have turned out for them. That doesn’t bode well for anyone who prefers market based solutions to problem solving via the price system.