Valuing the Olympics – Talk is Cheap
The London 2012 Summer Olympics kick off today, two weeks of international parading and guaranteed non-stop NBC coverage, but will these games create any real value for their host? It’s possible to track and forecast expenditures related to event construction and local tourism, but, as we have consistently seen, the net long-term benefits often differ.
Revenue generated from consumer spending around the Olympic Games will assuredly boost GDP growth in the short-term, but it’s hard to see this continuing beyond the end of the year. British Prime Minister David Cameron forecasts a $20 billion economic boost ($14B est. total cost) over the next four years. Given the current level of global uncertainty as the euro-crisis worsens, predictions like this seem to be overly optimistic. Although a temporary boost to employment should assist the British recovery, the UK’s latest unemployment rate of 8.1% already implies a slight recuperation.
Andrew Zimbalist, an economics professor at Smith College, believes there are three reasons why hosting the Olympics is a losing game: the bidding process is hijacked by private interest, the Games create massive overbuilding, and there is little evidence of meaningful increases in tourism. In a recent Atlantic article, Zimbalist explains that:
There may be a few former hosts that experienced a long-term economic benefit, such as Barcelona, but scholarly research has found that any gains are difficult to identify.
Even in an ideal world where aspiring host cities behaved rationally, the competition to land the games would leave the winner just about breaking even, or maybe with a small windfall. But we don’t live in an ideal world. In practice, host cities tend to be captured by private interests who end up promising much more than the city can afford.
In economic terms, hosting the Games doesn’t appear to be as beneficial as is widely perceived. As the demand to host drives the margin for profit lower, it is easy to see how the cost of the application process, planning at the local/regional/national levels, constructing infrastructure, and the ultimate postmortem recovery prove to outweigh most advantages. The Olympic allure, the enthusiasm that provokes development and supposedly brings long-term increases in tourism, is possibly the greatest value added as it motivates leaders to act.
Because the Olympics are an event where numerous leaders congregate within a short period of time, it should be a major priority of British officials to take advantage of this opportunity to drive foreign investment. These indirect networks are possibly the Games most beneficial side effect. Using the event as a launching platform, leaders should discuss possible opportunities to stimulate growth across many levels of the economy. London is Europe’s most attractive city for investment based on the number of FDI projects (see below). It has been 64 years since the city first hosted the Olympics, but any opportunities created at the upcoming games should be significantly more revealing as to our future economic prosperity.
Goldman Sachs recently published their Olympics and Economics 2012 report, a widely popular tradition that analyzes a wide array of economic influences related to the Games. The team forecasts everything from the number of gold medals each country is predicted to win to the Olympics influence on the stock markets, crafting the discussion around a variety of interviews. Their research on the overall economic benefit gained by the host country shows mixed results, with the 1972 Munich and ’76 Montreal Games loosing money while the 84′ Los Angeles, 92′ Barcelona, and 96′ Atlanta Games remaining profitable (NPR). This data further exhibits the Games inability to generate meaningful revenue across a wide period of time.
The London Olympic Organizing Committee has even gone so far as to drop 500,000 soccer tickets from the schedule, in attempt to manage attendee perception. This is a prime example of the lengths that officials are willing to go to protect the real value (the allure) that is generated. As budgets are slashed and governments aggressively pump money into lagging financial systems, it will be interesting to see what deals (if any) arise from the two-week festivities and if there will be any repercussions noticed at the athlete level.
Madrid 2020 !?!?
Looking forward to the 2020 Olympics, severely indebted Spain has entered a bid to host the games. The government states that most of the infrastructure is already in place so not much funding will be needed. If not much is going to be built, how will this project create any jobs? With tourism revenue proven to be less significant than previously believed, what value will this add to the country beyond nationalistic pride? In it’s current economic state, Spain is in no shape to be considered an Olympic host and should respectfully withdraw its offer.
The Marginal Utility of Central Banking
Economists often discuss the marginal utility of goods and services. For instance, your second donut is less satisfying than the first and by the fifth donut the value of one additional donut is slim. With each passing donut the marginal value of another donut is small. The question we now pose is does monetary policy and by extension all central banking have a marginal utility curve, and if so what is the optimal amount?
On one extreme you get the popular mantra “Abolish the Fed”. Free market advocates often side here explaining that central bankers have a terrible track record throughout history and most often make the problem worse. The Nobel Prize winner Milton Freidman was an advocate for this style of monetary policy well before it was in fashion. He went on record saying we should do away with the Federal Reserve and instead tie interest rates to inflation. One of the primary strengths of this strategy is that excesses are quickly cleared from the system often through deflation and liquidation. Famed investor Jim Rogers explains simply that recessions are like small forest fires that clean out the system of excess. If the fire is prevented the kindling accumulates until a larger crisis occurs.
The major downside of a Fed-free model is that the economy and asset prices become extremely volatile. In fact, the process that often clears out excesses is an increase in either inflation, deflation, or both. These periodic shocks make corporate planning very difficult, which in turn would create a higher reluctance to hiring, leading to higher unemployment. Moreover, a more volatile economy would likely lead to corporations holding more cash (like we have now), which leads to underinvestment and sub-optimal efficiencies.
The other extreme view is that the skilled hand of the federal bankers is a critical part of stability and crisis mitigation. When shocks occur the Federal Reserve can step in to provide liquidity. Perhaps the most famous advocate of this view is Paul Krugman, the Nobel Prize winning economist who frequently defends larger government action across the board. This strategy appears to be what central banks around the world have adopted, as explained in our piece It’s the Economy Stupid. The benefits of this strategy are transparent. The government has the ability to create liquidity, change the price of credit, or even become the buyer of last resort. These benefits, overall, promote price stability and more full employment. But the benefits of central banking can quickly become perverse.
In Naill Ferguson’s book The Ascent of Money: A financial history of the world, professor Ferguson explains how at the height of money printing in the Weimer republic it was a nightly event to see tens of thousands of youths gather into some sort of parade selling their bodies. Inflation was so high that “anyone with anything of value was happy to get rid of it before it was worthless, and anyone without any assets were willing to sell anything they had, including their bodies to gain something of value.” Similarly, Japan “engineered” a soft landing when the economy turned in the late 1980’s. Unfortunately, this soft landing has turned into a 25 year long runway. Central banking may add stability in the short run but can create massive instability if left unchecked. Today, we are starting to see cracks in high levels of central banking in Europe, Japan, China, and even the United States with quantitative easing becoming the norm and global interest rates racing to zero. So, one has to ask, is there an optimal amount of central banking?
I agree with Milton Friedman’s view that interest rates should generally be tied to some type of metric. Unfortunately, finding meaningful inflation data is difficult because of how it is measured. ShadowStats.com keeps data comparing the old way the CPI was calculated (prior to 1981) and the way it is calculated now, and the discrepancies are huge (currently they show the old CPI at near 11%). For this reason, I recommend tying interest rates to a basket of commodities such as the Rogers commodity index. However, during times of duress it makes sense to give central banks some freedom to act. I would suggest a set standard deviation from the index where the Federal Reserve would be allowed to act if the board agreed. Moreover, allocating Central Banks a PREDEFINED amount of money they can use to create liquidity in emergency situations would add a certain level of price stability without giving seven men carte blanch over our fiscal wellbeing.
A system like that discussed above would keep many of the benefits of having a central bank but would keep their power within reason. Today’s system promotes stability over resilience (ability to come back from massive shocks). Limiting the power of central banks would create a system that is both stable and resilient.
Schmidt vs. Thiel – Silicon Valley Showdown
Eric Schmidt (Google) and Peter Thiel (Facebook, PayPal, Clarium) engaged in a lively debate at Fortune’s Brainstorm Tech conference last week. For a full transcript follow this link.
Cutting the Cord
Baby boomers quite frequently support their children long after they have left the home. The June 25th issue of Investment News explains that, in general, children remain the largest single expense for baby boomers even after they have left the home. Parental support is lasting longer and longer as a result of the sluggish economy. High unemployment rates have greatly limited the opportunities for those under 30, putting parents in a position where it is tough to say no. Even college graduates are finding it difficult to find gainful employment on top of burdensome debt loads. In these scenarios many children are returning to live with their parents.
All of this is adding to the burden of retirement. Low interest rates, combined with two bear markets in a decade, have led to a situation where retirement accounts are decimated and future returns look anemic. At the exact moment that retirees should be stocking away more of their savings for retirement their adult children are taking a bigger bite.
Over time, the cost of raising a child to the age of 18 has increased dramatically (see below).
What is interesting is that the above increases don’t include costs after the age of 18, like college or moving back home. These costs are rising too; see our article on college costs.
This is a perfect storm for retirees. Raising children is getting more expensive, college is getting more expensive, children are returning home, retirement accounts are hard hit and growth is sluggish. The tightrope walk is difficult and everyone’s individual situation is unique, but, in general, I believe retirees need to be vigilant in planning for retirement. Balancing one’s own needs should be part of the equation when deciding to help out adult children, cart blanch should not be the default.
The economy is as ugly for those looking to retire as it is for those looking to work. Deleveraging is a slow and grueling process that usually continues until the excess is gone. Baby boomers that are helping support their adult children are probably as dismayed as young workers paying into a social security system they know is a joke. Understanding where your parents or children are coming from will be an important aspect in creating boundaries and will lay the foundation for finding the optimal amount of mutual support.
Rare Earth Shortage – Made in China
Nationalistic policies aimed at monopolizing resources are nothing new in the international trade arena. A regular candidate, the Chinese government, has joined this list (again) by continuing to tighten its grip on the countries relatively abundant supply of rare earth metals. The Information Office of the State Council, a government controlled agency, recently released its first white paper outlining the negative effects stemming from this industry. Chinese officials hold the belief that their country continues to be exploited by foreign corporations, significantly increasing its environmental and socioeconomic problems.
Rare earth metals include 17 different elements that are used in a majority of electronic devices, ranging from smart cars to smart phones. Almost all technological advancements in recent history rely heavily on these resources, forcing many to question the government’s true intentions behind the crackdown. It seems that the underlying motive is to force manufacturers to purchase resources from one of the state mandated supplies, ultimately controlling the market.
The Chinese have maintained a dominant role in supplying rare earth metals because of there cost-effective ability in extracting the elements. The country only holds an estimated 23% of the global reserves, but has crowded out foreign competition by undercutting production costs, leading to over a 90% stake in the global rare earth metal production (Chinese Gov, IOSC). The reason that Chinese rare earth metal producers, especially the government sanctioned ones, are able to undercut the majority of international competition is due to a multitude of macroeconomic strategies (Yuan peg, trade tariffs, etc) that are fully discussed in this article.
The US Government, along with numerous other international leaders, has brought this issue to the attention of the World Trade Organization because it is a violation of international trade laws. When China joined the WTO in 2001, they did not include rare earth metals in their export exclusions, but are now justifying the addition through environmental concerns.
In my opinion, this heightened regulation is a cover for the government’s consolidation of the rare earth industry. As consumer demand grows for products that utilize these metals, the Chinese government continues to tighten its control over suppliers to profit from the manipulation of market prices. Not to downplay the need for global environmental regulation, but it seems a little suspicious that China is just now stepping up to the plate and releasing research.
Japan is China’s largest trading partner for rare earth metals, accounting for 56% of exports in 2011 (see graph above). Scientists have recently discovered a massive deposit of rare earth metals off of the Japanese coast, stating that it “is enough to supply its hi-tech industry for more than 200 years”. Although this is years from production, deposits such as this will help wean international dependence off of China’s supply, rendering any ulterior motives useless.
In the short-term, we expect the price of rare earth metals to escalate on low supply of international producers, spurring increased exploration and production of new deposits like the one found in Japan. Production will lag as additional operations come online, forcing current manufacturers to continue purchasing from the main supplier in town. This will leverage China’s power as the number one rare earth supplier in the immediate future, but as market forces shift, I expect the power to become less efficient.
Additional companies that are pushing to become the first major supplier of rare earth metals outside of China include Lynas Corporation and Molycorp. Two mines that are nearing production, located in Malaysia and California, have faced multiple setbacks as they attempt to enter into production.
The industry is hopeful that the Lynas Advanced Materials Plant (LAMP) will start producing in the near future; stating that its plant is currently 98% complete and the government infrastructure for successful operations are in place. Anti-mining groups, such as Save Malaysia, regularly speak out against the environmental damage caused by proposed operations and the long-term cost to the locals. Lynas has faced multiple appeals, but successfully defended it’s two-year operating license.
Molycorp’s flagship facility is Project Phoenix, located in Mountain Pass, California. The firm expects the project to reach Phase 2 by mid-2013, producing 40,000 metric tonnes annually. So far in 2012, Molycorp has increased proven and probable reserves by 36%. Expansions in exploration and production, like at the Project Phoenix site, will be continue to be extremely vital in meeting global demand.
The Information Office of the State Council has clearly stated it’s intentions to stockpile rare earth metals to create a state reserve. Ever since a government press release in May 2011, their has been multiple rumors of the Chinese government hoarding these elements, presumably, to manipulate global supply. The government solidifies these rumors by specifically stating it’s concern for the supply of europium, terbium, dysprosium, and yttrium in their recent white paper (via RareMetalBlog). It is still unclear to what degree the major producing companies are contributing to the state reserves, but I’m sure they will be heavily compensated through government subsidies, continuing to widen the gap in international production costs.
The environmental regulation, related to the mining of rare earth metals, will persist as a necessary cost derived from processing these elements. A majority of international producers have implemented precautionary safeguards and strive to operate within an acceptable threat range, posing minimal harm to local communities. The current environment needs regulatory oversight to make sure that safety standards are improved and markets are left free to fluctuate, but don’t be fooled by China’s weak attempts at consolidating the industry.
Outsider Trading 