Requiem for the Dollar

Constantine the Great created the solidus, a gold coin that held its value well enough to be a monetary standard for seven hundred years.  The Bretton Woods monetary system survived a quarter century.  The U.S. dollar is worth maybe 5% of its 1900 value.

Jim Grant, the sage of the bond market, writes in the Wall Street Journal a lengthy, witty, thoughtful, and ultimately depressing "Requiem for the Dollar. "  He tells us, "To give modernity its due, the dollar has cut a swath in the world. There's no greater success story in the long history of money than the common greenback. Of no intrinsic value, collateralized by nothing, it passes from hand to trusting hand the world over. More than half of the $923 billion's worth of currency in circulation is in the possession of foreigners."

Yet like all great schemes it has its limits.  "But now the world is losing faith, as well it might. It's not that the dollar is overvalued—economists at Deutsche Bank estimate it's 20% too cheap against the euro. The problem lies with its management. The greenback is a glorious old brand that's looking more and more like General Motors."  Ouch!  Take away my membership in the American Economics Association before you compare me to Rick Wagnoner!

The strength of the dollar is of both economic and geopolitical significance. 

Stable monetary values make economic calculation easier and facilitates prosperity.  Unstable money gives incentives to speculate and invest capital and human energy into unproductive activities.  Diverting human and financial capital form productive activity makes society poorer.  It is one of the two legs of Robert Mundell's "policy mix," which not only won him a Nobel Prize, but also is the foundation of Supply-Side Economics as Brian Domitrovic demonstrates in his new book, The Econoclasts: The Rebels Who Sparked the Supply-Side Revolution and Restored American Prosperity." 

Our current international financial system has no anchor in the real economy.  We have floating exchange rates that float whithersoever the whims of speculators send them.  Wallace and Sargent demonstrated three decades ago that floating exchange rates have no equilibrium.  The result is uncertainty in trade, profits for banks, and the diversion of many clever folk into speculation.

President Obama's new realism (see "Is there an Obama Doctrine?" in the Economist) seems to say that we as a superpower will assert our selfs, if we can afford it.  With such an anemic dollar it is hard to say we will afford much!

The Good the Bad and the Ugly: The Weak Dollar, CIT's Bankrupcy, Aircraft Leasing

1) The economic recovery: Real GDP grew at a 3.5 percent seasonally adjusted annual rate in the third quarter after falling five of the previous six quarters. Jeff Bator in the Wall Street Journal writes, "[A]fter a bullish report on manufacturing suggested the smokestack sector is in a hiring mood., ...U.S. factory goods orders rose in September...0.9%, the Commerce Department said Tuesday, the fifth increase in six months. Orders fell an unrevised 0.8% in August."
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World trade bottomed out in April and our national economy's recovery started in June according to my best estimate.

2) The main opportunities and threats to recovery here in Wichita: the weak dollar is helping make American aircraft more competitive vis-à-vis Airbus and Embraer.  In the Wall Street Journal, Mike Spector Vanessa O'Connell and Kate Haywood reported that CIT filed for bankruptcy "in New York, listing assets about $71 billion and nearly $65 billion in liabilities." CIT's bankruptcy shows the fragile financial shape of the aircraft leasing business.  CIT Aerospace is a major aircraft lessor with aircraft worth something in the vicinity of $10 billion.

Seven aircraft leasing companies (GE Capital Aviation Services, AIG's International Lease Finance Corporation, CIT Aerospace, Royal Bank of Scotland Group PLC's RBS Aviation Capital, Bank of China's BOC Aviation, Pacific LifeCorp Inc.'s Aviation Capital Group, and Pembroke Group, a unit of Britain's Standard Chartered PLC) are big customers of the aircraft manufacturers.   Last fall, we were shocked to discover that AIG was Boeing's and Airbus' biggest customer. Daniel Michaels at the Wall Street Journal estimates that approximately 35% of the world's jetliners are owned by these lessors.  Thus these lessors' own $147 billion of the world's $417 billion worth of jets. The larger lessors are all in shaky financial shape.  This means the biggest set of customers for Airbus and Boeing (Spirit's customers) face severe financial constraints to their buying planes.

Earlier we wrote, " AIG has been trying to sell ILFC for a year. Steven F. Udvar-Hazy, chairman and chief executive of International Lease Finance Corp., is trying to work a deal whereby he and investors carve out a part of ILFC and go it alone.  The investors are supposed to be mostly from the Middle East and China." The commercial side of the aircraft industry has held steady so far.  With Wichita's unemployment rate at 8.6 percent, let us pray this is not the other shoe ready to drop.

Henrique de Campos Meirelle On Brazil's Success Through the Financial Crisis

Henrique de Campos Meirelles is the Governor of Banco Central do Brasil. Maybe Ben Bernanke could learn a thing or two from this interview with the economist:

Maybe You Prefer Pisner Urquell or Budweiser (from České Budějovice!) or Klášter, But István Szoke Thinks Staropramen Is a "Hidden Gem."

The MoneyMeisters (I can not call them breumeisters) at Anheuser Busch InBev are shuffling their portfolio.  They are selling to private equity investors, CVC, their eastern and central European operations and distribution system for $2.2 billion.  Matthew Curtin judges "CVC is paying around nine times last year's Ebitda assuming it hits its return targets, triggering another $800 million payment to ABI. CVC will fund the deal with $1 billion in debt raised from a variety of banks. The three times debt to Ebitda is well below the six times-plus multiples typical during the boom."  EBITDA is earnings before interest, taxes, depreciation, and amortization.  It is an operating cash flow approximation that is often used in valuations. Lex in the Financial Times adds, "Evolution Securities estimates $2.23bn represents about eight times 2009 earnings before interest, tax, depreciation and amortisation. That is some way below the 10 times-plus of big boom-era beer deals but for AB InBev it is respectable enough, given the potential extra $800m payments."

Matthew Dalton fills out the price: "AB InBev will receive $1.62 billion in cash for the Central and Eastern Europe assets. AB InBev will also receive a $448 million unsecured deferred payment obligation from CVC with a six-year maturity that can be extended 2 years, paying interest at between 8% and 15%. Finally, AB InBev will get $165 million in minority interests."

He tells us "The operations being sold are located in Bosnia-Herzegovina, Bulgaria, Croatia, Czech Republic, Hungary, Montenegro, Romania, Serbia and Slovakia."  CVC gets to "brew and/or distribute Stella Artois, Beck's, Löwenbräu, Hoegaarden, Spaten and Leffe -- AB InBev's main brands in Europe" in those countries.  They acquire, among other brands, Staropramen.

InBev wants to focus on big brands in big countries.

But how good a deal is it for the buyers?  Yes they are paying less than the heady multiples of the bubble years. It looks like they have been clever in structuring it.  Interestingly, according to Martin Arnold and Philip Stafford, "István Szoke, head of CVC’s new central and east European buy-out team, told the Financial Times that Staropramen was 'the hidden gem' among the assets."

The deal turns financially on buying at the bottom and an eventual recovery in revenues as the local economies recover.  Mr Szoke told FT, "We think we are buying this business at somewhat of a trough, as we expect the [east European] region to recover and grow, which will benefit the top line of the company." The Czech Republic, a world leader in beer consumption, is like the caboose on a train in the globalized economy.  “We were surprised by how hard beer consumption has been hit in the region,” said Mr Szoke. “But beer consumption is driven by disposable income and that will recover once this crisis ends in a year or so.”  Since world trade started turning around in early spring, maybe the caboose will make back to the pub by next year.

The Rise of the Loonie

The Canadian dollar is so strong, the Bank of Canada may intervene lest a too strong Loonie stifle the recovery north of the border.

The State of General Aviation and the Consequences for Wichita

The National Business Aviation Association conference is opening in Orlando, Florida next week.  It and surrounding events will provide focus the business world's attention on general aviation and the economic hammering it has taken.  The Wichita Eagle's Molly Mullins in a big Business Section feature surveys the damage, "The state of Kansas' business aviation industry."


She writes:


"Nobody saw this coming.


"Thousands of jobs lost. Production cuts. Furloughs. The cancellation of a major new aircraft program.


"The global financial crisis hit the business jet market hard and fast and put Wichita's lifeblood industry in an agonizing free fall.


"A year later, there is evidence that the global economy is in the early stages of recovery. But for business aviation and Wichita planemakers, the climb back will be long and slow."

Back in March, 2008, I argued that the national economy had been in a recession for six months or more ("What is Good for Wichita Is Hemlock for Wall Street.") The National Bureau of Economic Research eventually dated the recession to have started in December, 2007.  Few fully appreciated the extent of the general aviation bubble ("2007 Increasingly Looks like It was a Bubble Year for the Aircraft Industry.")  The bursting, when it came in the fourth quarter of 2008 was dramatic. 


Peter Sanders at the Wall Street Journal reports on the effect of the aviation downturn on Wichita's economy noting that "more than a quarter of the area's aviation work force has been let go, not including thousands more layoffs among parts suppliers and support businesses."

Cessna's New Orders "Nosedived" In the Fourth Quarter of 2008

To amplify Sanders' report, Cessna's new orders, net of cancellations, averaged about $2.4 billion a quarter in the first three quarters of 2008.  They fell over 80 percent to $400 million in the last quarter.  (These are my estimates based on Textron financial reports.)

Outsourcing

Sanders also reports on a "recent push to manufacture offshore that many Wichita aerospace companies have embarked on. Some companies have opened operations in Mexico. During the boom times in late 2007, Cessna announced it would build a new, small propeller plane in China. That plane would be shipped to Wichita for reassembly and delivery to U.S. customers.


"While the companies are guarded about their plans in light of the downturn, officials concede that it is unlikely that they would expand their Wichita operations beyond today's level. Any future growth would probably happen abroad."

Commentary

A few points:

1) 2007 was a bubble year for general aviation.  Look at the new orders data. 

2) The bubble was fueled by the same over expansion of credit that fueled the housing bubble. 

3) The negative short term interest rates of 2002-2004 enabled (should I say caused?) the credit over expansion.

4) The general aviation industry over expanded in 2008. 

Fun Question: Would Cessna have expanded production as much in 2008 had it been independent rather than owned by Textron?


5) On the commercial front, Boeing expanded much more cautiously.  Compare Boeing's production in the run-up to this recession with its production in the run-up to the 2001 recession.   This has allowed Spirit to hang tight and manage for the longer run.

Fun Question: Do you attribute that to good management, conservatism, or technical delays?

6) Hypocrisy in Washington about corporate jets is business as usual.  Congress votes to appropriate for themselves a more elaborate fleet of planes than the Air Force requested.  Simultaneously, it pillories corporate executives.  (For the Journal, Brody Mullins and August Cole reported in August, "the House more than doubled the [Air Force's] request to $550 million for a total of eight new passenger planes for use by government VIPs.")

7) Outsourcing has its drawbacks as the yo yo economy of 2008 demonstrates.  

8) Outsourcing means having less control.  Boeing has had to buy back three of its suppliers to get the Dreamliner back on path.


9) The administration's fiscal policy and the Fed's monetary policy represent more than the benign neglect of the 1980s.  This may be Washington's real industrial policy.  Let the dollar get so worthless that manufacturing will find it cheaper to come home.  We can debate whether that is a plan.

In the long view of things, Wichita's current 8.9% unemployment rate (10% in July) is collateral damage from Alan Greenspan's and Ben Bernanke's misjudgment that preventing bubbles was not their job.  As in the refrain from the old Pete Seeger song goes, "When will they ever learn?"

Elinor Ostrom and Oliver E. Williamson Win the Nobel Prize In Economics

"Governance" is the key word in this year's economics announcement.   How do people come up with organizational solutions to problems other than individulalistic market transactions or centrally imposed solutions?  How do they solve issues of collective rights?

The Committee tells us "Economic transactions take place not only in markets, but also within firms, associations, households, and agencies. Whereas economic theory has comprehensively illuminated the virtues and limitations of markets, it has traditionally paid less attention to other institutional arrangements. The research of Elinor Ostrom and Oliver Williamson demonstrates that economic analysis can shed light on most forms of social organization.

"Elinor Ostrom has challenged the conventional wisdom that common property is poorly managed and should be either regulated by central authorities or privatized. Based on numerous studies of user-managed fish stocks, pastures, woods, lakes, and groundwater basins, Ostrom concludes that the outcomes are, more often than not, better than predicted by standard theories. She observes that resource users frequently develop sophisticated mechanisms for decision-making and rule enforcement to handle conflicts of interest, and she characterizes the rules that promote successful outcomes."


Understanding why the firm exists is one of the crucial questions of economics and not one extensively explored in mainstream economics. 

I am fascinated by Ostrom's award.  How people work out collective rights with neither a simple market solution nor government imposing one is a great area of inquiry.  Here we get to the nexus between law and spontaneous order.   What is the relationship between economic regulation and property rights?  When does positive law harm collective decision making? I have some reading to do!

One issue from the financial crisis to which Ostrom and Williamson's work is directly relevant is whether investment banks behave more responsibly as partnerships rather corporations.  Their excessive risktaking seems directly related to their going public.

Speaking of the financial crisis and organizational forms, maybe the committee should give George Benston the Nobel prize posthumously for demonstrating empirically that banks with investment affiliates performed better than those without.  In other words,  Glass Steagall's separation of investment from commercial banking was more about Senator Glass's Anglophilia than economic sense. Glass Steagall left investment banks outside prudential regulation. If the SEC had that responsibility, it is hard to see it in its history. Thanks to the structure set up by Graham Leach Bliley, all the major investment banks are either owned by a commercial bank or have become bank holding companies and are now under the Fed's prudential regulation.

The Unemployment Rate Goes to 9.7% and Payrolls Drop "Only" 216,000

The Bureau of Labor Statistics reported on the August employment situation this morning.

The Nation

The national unemployment rate rose to 9.7 percent in August from 9.4 percent in July and 9.5 percent in June.  The size of the labor force still reflects the upsurge we saw at the beginning of the summer.  The month to month variation in th employment rate mostly reflects the sampling variation in the proportion of respondents who say they have jobs.

Non-farm payrolls fell by 216,000 in August.

April Is the Cruelest Month

The Bureau of Labor Statistics survey of households shows a drop of 1,351,000 employed since April, while the payroll survey shows a fall of 1,258,000 jobs.  The good news is that new unemployment claims peaked in April.  Historically this has been a reliable indicator of a recession's end.

Wichita

Although BLS did not report job losses for the aerospace industry, transportation equipment other than autos and auto parts fell by another twelve hundred for a total loss of 17,100 since April.

AIG's Financial Crisis and Boeing's Biggest Customer

Boeing and Airbus's biggest commercial customer is not an airline but the fallen insurance giant, AIG (see my earlier  posting "Who's Boeing's and Airbus's Biggest Customer? Would You Believe AIG?") AIG's financial Götterdämmerung forced International Lease Finance Corporation (ILFC),which it owns, onto the Fed's life support system last October.  When AIG lost its investment grade rating, ILFC could no longer access the commercial paper market to roll over its short term debt.

AIG has been intent on paying off the $80 billion federal debt that keeps it in bondage to Washington.  The strategy has been to sell off assets.  The flaw in this strategy has been that you get Filene's Basement prices not Neiman Marcus prices when you dump assets at market bottoms when buyers know you have to sell and the few who have the cash bargain hard.  In the Wall Street Journal, Matthew Karnitschnig and Liam Pleven tell us AIG's new CEO, Robert Benmosche, is reconsidering its asset sales strategy. 

AIG has been trying to sell ILFC for a year.  Now Peter Sanders and Daniel Michaels also at the Wall Street Journal write that Steven F. Udvar-Hazy, chairman and chief executive of International Lease Finance Corp., is trying to work a deal whereby he and investors carve out a part of ILFC and go it alone.  The investors are supposed to be mostly from the Middle East and China.

The Hungarian born "Mr. Hazy is a co-founder of ILFC, which now owns about 1,000 aircraft, most of which are leased to commercial airlines world-wide. ILFC is the largest customer of Boeing Co.'s upcoming 787 Dreamliner, with 74 planes on order."

It is important to Spirit that a major support for the demand for commercial aircraft have the financing to buy planes and maintain its existing portfolio.  Boeing was more conservative expanding production in 2008 than its general aviation brethren seeking not to repeat the mistakes of the late 1990s.   So far Spirit has done a laudable job maintaining its workforce for the future.  We in Wichita where the unemployment rate is now 9.9 percent hope that continues. 

Steven F. Udvar-Hazy and General John R. "Jack" Dailey at the overlook of the new Center.
Photo by Carolyn Russo, National Air and Space Museum