Thursday morning radio: the economy on WREL

Mike Smitka

Well, I've gone through another week without a post on the auto industry, but Thursday has come and my WREL Lexington (VA) radio segment with it. Here's my latest.

First, our host Jim Bresnahan asks about the gyrations of global stock markets. China? – attributing a reason to what happens in the stock market is hard. As an economist I don't pay attention to the stock market, because how it does has no link to the economy in the short run, and little or no impact on the economy. Most trading now is computer to computer, operating faster than the blink of an eye, and opaque in details. So why things move in a particular direction, and how much, no one can explain. Now the reporter on CNN has to give a report every hour, and we as humans like things to have causes, and they'll attribute the up or down to something. So in the short run the market is random, and betting on it is a crap shoot, one where the house – Wall Street – wins. You have to pay a fee, and the computers can see your trade before it gets executed and (legally – there's no regulation) bet against you. As to the US, we're seen a strong rise in the market the past few years have seen; the US economy has after all been growing, and corporate profits are up. Stock prices ought to reflect that, but the link is loose so things will go up and down. Don't panic, invest for that long-run link and don't let yourself try to beat the house in the short run.

Now as to China as a cause of the gyrations, what's been happening in China is not news. Of course I'm better informed than average. I've been teaching a course on the Chinese economy since I came to Washington and Lee almost 30 years ago, and first studied China when I was a freshman in college, over 40 years ago. I can read Chinese, albeit slowly and speak a bit. There are a couple historians in town, and literature and language specialists, and I can't begin to compare to them. But in this area I really am the go-to person. So here's what I see.

That the economy there is slowing, well, it began slowing a couple years ago. Over time an economy can grow only as it has new inputs, capital, labor, technology. China's population is no longer growing – and in a few years will begin falling – and the working age population is already in decline. That's been offset by migration, people moving from farm to city, but that is coming to an end. Much of the countryside has emptied out, and in particular there are very few young people working as farmers. That's the labor side, clearly slowing.

Then there's capital. China is the size of the continental US, and has completed its expressway system, which is more extensive and of course in better shape than our interstate system. That created a lot of jobs, and as in the US, that sort of construction also generated a lot of corruption. (We've forgotten how bad things used to be here, as over time we developed systems to monitor public works, while politicians have developed alternative, and more reliable, sources of funding.) Anyway, lots of other infrastructure is now also in place, and while cities are still growing, even there housing is often ahead of demand. For other sorts of capital China has also built up their economy. There are three times more cell phone users in China than in the US, and so the market is no longer growing, and most of the phones are made inside China as well. A lot of computers are in place. So capital accumulation is naturally slowing.

Then there's technology, one measure of which is total factor productivity. China has learned how to assemble cars, and while most of the engineering took place in Detroit and Wolfsburg – General Motors and Volkswagen control the top brands – the factory end is now pretty sophisticated. Cell phones are assembled in China, and more and more of the chips are made there. The world's largest PC company, Lenovo, is Chinese, and their universities graduate a lot of electrical engineers. While Lenovo started out by buying IBM's PC business, they now have enough experience to continue pushing the business themselves. So while China will keep improving, they're well along the catch-up process and the easy gains have already been made.

Hence China's headline growth has fallen from 10% to 7% and henceforth they'll slow to 4%-5%. That's still much faster than the 2% growth of the US. But as to the stock market, this slowdown was known to be happening, indeed was written about 20 years ago. The details of timing weren't know then, but the general outlines were clear. So what's happening in China isn't news and shouldn't have much effect.

Now there is the collapse in stock prices and some sectors of real estate. Chinese investors are not experienced, and many are naïve. In addition, for a variety of reasons Chinese bank accounts pay nothing. So as incomes have risen, money has flowed into stocks and real estate, and they've not been thinking carefully about long-run values. So there are a lot of empty apartments and people who have bought stock on the basis of rumors. While corporate accounting is much better, it's still weak – not that we don't have our scandals – so it's not always clear what you're buying. In any case, prices had no basis in reality and are now coming back to earth. Unfortunately it's very hard to work with that. Diagnosing a bubble is hard, and the tools that might pop it are also likely to trash the wider economy. So fighting a bubble can do more harm that good. But it's not clear why Wall Street should react strongly, since (unlike between Europe and Japan and the US) direct links between the financial system of China and those of other countries are weak.

Separately, there's a bit of news on the US end. Over the last 3 months housing prices have on average fallen a bit. Construction is back to growing on the pre-crash pace – but not at pre-crash levels. We're still down about a third – 31.6% to be precise – but there's no sign we're moving back towards prior levels. That's not good news. So while it's a backward-looking number, it will be interesting to see what we learn from today's release of GDP data.

Now we're about out of time today, but next week I want to talk about changes in the labor market at its two extremes, teens and older workers. During the Great Recession teen employment fell by one-third, but had been declining even before then. Are teens no longer interested in afterschool jobs? Or is there a lot of slack still, lots of people looking for jobs, and employers prefer to hire anyone but teens?

Then there's the older end. In 1981 only about 400,000 people aged 75 and above were working; today over 1.5 million older Americans are working. Some of that is simply that there are a lot more older Americans; our population is aging. But the share of older Americans working has also risen. So what's going on there?

More next week!

Low oil prices: not a Saudi conspiracy

Mike Smitka

Saudi Arabia is not what it used to be. Their petroleum and other liquids production in 2014, at 11.6 million barrels per day [mbd], is only about 1 mbd above what it was in 1981 (and is just shy of the peak over the period 1980-2013). But their market share is distinctly lower, falling from 17% (of global output of 60.6 mbd) to under 13% (of 93.0 mbd). That limits their pricing power.

Elasticities tell the story. The short-term price elasticity of demand is about -0.2, the medium-term one of course is more elastic at -0.5 or greater. [In most energy markets the income elasticity of demand is roughly 1, though recent work finds it is less in the OECD.] So if the Saudis cut output by 10%, global output falls about 1%. That means prices rise 5%. But with the quantity they sell down 10% and prices up only 5%, that means their income falls by 5%. With a population burgeoning in numbers and expectations, and as the ideological seat of the Wahhabi sect that fuels radical Islam – but so far has not seen cause to bite the Saudi hand that feeds them – well, the kingdom can't afford a large income hit. Oh, and they're consuming what to me is a surprising amount of oil.

One other bit of economic logic reinforces this argument: when interest rates are low and prices are low, it makes sense to leave oil in the ground rather than to pump and sell it. Selling turns oil into bank deposits, and those earn nothing. Leaving oil in the ground also provides the option to benefit from future price rises [though the option loses its value if prices fall further]. So do you want to store your oil in the ground, or store your oil in the bank? (Those with finance acumen can do the corresponding net present value calculation, and maybe even put a valuation on the option.) For the Saudis, pumping oil makes sense only if their focus is cash flow rather than maximizing national income.

Now if OPEC (or at least the Middle East subset) was a true cartel, the Saudis could count on others cutting back as well. That changes the arithmetic in favor of cutting output. But Iraq needs to pump every barrel they can, and Libya and Iran as well. Such lack of discipline is reflected in the history of OPEC: in the past, whenever prices were low, attempts by the Saudis to drive up prices were offset by rampant cheating by other OPEC members. There's no reason to think today would be different. But in the past the Saudis were big enough to go it alone; today they're not.

Now the other part of the accusation is that the Saudis are after market share, not revenue, and that by keeping prices low they'll drive new entrants out of the market (which means production in the US! - they're our friends?). Of course [to an economist!] in general the predation story does not make sense, because would-be predators incur up front costs that typically far offset any putative longer-term gains. But in this case the story is worse.

Yes, many firms in the oil patches of North Dakota, Oklahoma, Texas and Ohio/Pennsylvania are bleeding badly or in bankruptcy; rig counts this year are down by 50%. But Chapter 11 bankruptcy is a wonderful thing, however horrible the overhead can be in delay and legal fees. Debt disappears, businesses do not. For those businesses that are not viable there's Chapter 7 bankruptcy. The businesses vanish, but the assets get sold – they don't disappear. Yes, skilled workers will scatter, but theirs is a geographically mobile existence and they can be enticed to show up again. (The on-again off-again nature of such work is one reason wages are so high.) Oh, and 50% remain, and those 50% are drilling in the best spots and/or have the lowest costs. So the moment the Saudis think they've won and ease up on the pump, well, the US industry will be back in business. What then would the Saudis gain? – a period in which they get less money for what they pump, but no ability to enjoy years of high prices! The Saudis understand this very well.

In sum, the claim that the Saudis are pumping a lot of oil to try to drive new producers (particularly US frackers) out of business is ludicrous. To reiterate, low prices may curtail additional drilling today, but that's scant help to Saudis in keeping prices high tomorrow and the day after.

Data: Energy Information Agency, Monthly Energy Review. Using "Total Petroleum and Other Liquids instead of "Crude Oil Production" does not change the percentages more than a tad but production volumes are higher. The historic series for the latter longer, so I created a second chart. For rig counts and other current data, see WTRG Economics.

Further reading:

Butler, Nick. "Oil Prices – The Saudi Dilemma." FT Blogs | Nick Butler, August 16, 2015.

This is a puzzling presentation of the predation line by an experienced and generally thoughtful energy analyst. What Butler is saying is that the new King Salman bin Abdulaziz al-Saud and his young (age 30) economics deputy Crown Prince Muhammad bin Salman don't understand what they're doing. (On re-reading he doesn't mince words, stating the King, age 79, and oil minister, age 80, are "out of touch.") I'm a sceptic, and believe it really is in the leadership's interest to pump a lot of oil – but history is full of potentates in their dotage who aren't well advised, or (in this case, with the King a newcomer) who in the interest of cementing their hold on power ignore experienced advisors whose tenure goes back to their predecessors.

Gately, Dermot, Nourah Al-Yousef, and Hamad M. H. Al-Sheikh. 2013. “The Rapid Growth of OPEC’s Domestic Oil Consumption.” Energy Policy 62 (November): 844–59.

It's not just China that's increased petroleum consumption. I was surprised by the magnitude of OPEC's thirst, I obviously need to work against my presumption that populations in the Gulf region are too small for their consumption to matter.

Hamilton, James D. 2008. “Understanding Crude Oil Prices.” Working Paper 14492. National Bureau of Economic Research. http://www.nber.org/papers/w14492.

This is a good overview of issues. Warning: Hamilton is among other things a very good econometrician, and the overview assumes a familiarity with the technical jargon of economics, e.g. "random walk without drift". He blogs (with Menzie Chinn) at Econbrowser.

Hochman, Gal, and David Zilberman. 2015. “The Political Economy of OPEC.” Energy Economics 48 (C): 203–16.

They provide more (and more current) detail than Hamilton on the behavior of OPEC. It is as the name plainly says an "organization." It is (empirically) not a cartel, whatever pronouncements individual oil ministers may make from time to time. Remember, to an economist deeds speak louder than words.

Thursday Update (albeit posting late)

Mike Smitka

I do a weekly radio segment on the economy on WREL, the local Lexington Virgina AM radio station. Here are my notes from the Aug 20th show. These are not necessarily the order in which I presented them, and I avoid numbers when I can - radio is not the medium for conveying data – but I like to have them in front of me.

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Employment: I won't talk details, but job growth continued to trend somewhat above population growth, with no sign of acceleration. Projecting out, as I've mentioned periodically for the past two years, we won't return to normal levels of employment until 2017 and more likely 2018. I'll return to that topic later in the fall.

New Residential Construction: The latest data were out Tuesday [Aug 18]. The showed slow improvement, especially for multifamily units, the latter something we've seen all this year. For all the feel-good headlines, residential construction is still only level of January 1992 when the population was 20% smaller [321 mil today vs 255 mil then]. Corrected for population growth, the adjusted rate is still below any point of the last 60 years – we're at about the 1990 trough, but still below the level of the early 1980s housing bust. [If numbers are bad on radio, graphs are worse, but I can include here!] The recent peak was in January 2006. Today we're at half that level [49%] in per capita terms. Times are good only if you don't remember what things were like a decade ago, before the Greenspan-Bush bubble burst: relative to April 2009, well, housing starts are 2.4x that level! The bottom line is that housing continues to be a big drag on the economy.

CPI:  headline CPI for July was 0.2%, and for January - July [compounding the geometric average of 0.09%] it averaged an annual rate of 1.0%. Now there's the drop in gas prices, while food prices are falling despite the California drought. Those pull down the headline number; inflation less food & energy is higher at 2.3%, though for past 3 months that number has trended down. [A query for my students come September: how volatile are the data? – do 3 months a trend make?]

The standout: services excluding energy-related rose at 2.8% and shelter at 3.5%. But "medical care commodities" rose only 1.9% and "medical care services" only 2.2%, both below overall the "core" rate of inflation and both below the level for recent years, perhaps reflecting cost controls of Medicare.

Too many numbers to discuss but: 16% trimmed-mean CPI and median CPI are down a bit to 2%, sticky price CPI at 2.1% is up a bit. As noted, overall headline rate 0.2% from year ago, but headline inflation less food and energy was at 1.8%. All combined, the data don't indicate a trend, up or down.

Energy: I was in California recently, and saw gas prices well over $4. Returning to Virgina, I was surprised to see prices approaching $2. Lower oil prices have had a huge impact – though CA has more taxes and due to smog issues a more expensive type of basic gasoline, so their prices won't get as low.

Separately, the drill rig count is down 50% so far this year. Of course the half still drilling are doing so in the most productive geologies. Well output drops quickly in places such as North Dakota and Oklahoma (falling by half over two years – my recollection is the rate is faster). So total output won't keep rising, but with continued drilling neither will production collapse. Meanwhile the weak global economy means demand isn't strong.

Is this collapse due to a Saudi conspiracy, to preserve their market share? That misses the arithmetic of what output changes do: the Saudis are today a smaller part of global market and their behavior has less impact. If they cut output 10% or about 1 mb/d, it could – would! – drive up prices. However, my back-of-the envelope calculations suggest prices would rise by perhaps 5%, not by enough to increase their revenue. So this [-10%+5%] implies their income would drop 5%. With a burgeoning population (and an ever-bigger royal family!) that has high expectations, the Saudis need money to buy off their people. It's made worse by the royal family's dependence on the Wahhabi movement, which provides the religious foundation of (Sunni) Islamic fundamentalism. The Wahhabis helped the Ibn Saud gain power, and the House of Saud supports them today, bankrolling Wahhabi schools around the world. There's plenty of irony that our "good friends" the Saudis support the movement behind the ideology of terrorism. In contrast Iran's Sunni fundamentalism is more nationalist than terrorist – indeed they are quite effective in fighting ISIS and el Qaida. Why are they our enemies? That's a topic for Mark Rush (W&L politics) and Pat Mayerchak (retired VMI Intl Studies) on their WREL radio segments, as both are are knowledgeable about and have lived in and visited the region.

ACA: In California I attended a nursing conference along with my wife, and as part of a presentation on the Affordable Care Act. There I saw a video put together by a reporter who asked people on the street about ACA and Obamacare. What the reporter found was that most hated "socialist" Obamacare, but loved the Affordable Care Act. Of course they are one in the same thing. If the people on the street base what they say on their personal experience with ACA, they seem to understand that it does what the name suggests, the policy has been a success. But the average person is unable to connect that with what they hear on Fox news. Even media not dominated by preconceptions contributes to such confusion, as they hear "balanced" reporting that gives air to "the other side" – even when the facts show there is no other side!! Of course these healthcare professionals have to deal with patients who through the internet and advertising and talking heads "know" what ails them and which medications they need. It was (hopefully!) a sobering lesson for the healthcare professionals who comprised the audience, though the clip was shown because of survey data suggesting healthcare professional have very little understanding of the ACA.

This should serve as a caution as the Republican primary heats up. Most of what I've heard doesn't make sense, and some of what is coherent is either wrong or would be bad policy, not producing the results the candidates presume. The primary is about putting together sound bites, not putting together policy. As we approach next year we'll have platforms and position papers and issue speeches, but for the moment most of what is said on the hustings leaves me as an economist speechless, that is, I have nothing to analyze.

Interest Rates: the Fed has already been acting. The taper is over, and long-term assets are falling, from $2.09 trillion to $1.94 trillion or -9%. Most of the other special lending has been nil for 5 years. While 30-year rates not as low as early this year, they have been falling since June and are under 3%. As I claimed at the time, the taper in fact didn't lead to rising rates. Now the Fed is indicating it will likely boost short-term rates by the end of the year, which will surprise no one, most of all financial markets. Remember, too, that rates are 0% and thus "boosting" will be to raise short-term rates to 0.5% at most, which is still low! Anyway, in expectation of this increase 1-year rates have gradually risen to 0.4% and 3-year rates to 1%. Those rates are still extraordinarily low, and the implication of a fairly flat yield curve is that a 1-year bond in 2018 will yield only 2.5%.

The bottom line: markets expect interest rates and inflation to remain very low for years to come.

China: there's lots of talk of depreciation, but it's really a dollar appreciation. Indeed, once we recognize that China trades with the whole world – Europe is more important to them than North America – the RMB (the currency's official name, it's the yuan in common parlance) is in fact stronger than a year ago. Why? – because the dollar is stronger relative to the currencies of Europe, Japan, Korea and Southeast Asia as well as Canada and Mexico. The flip side is that it's a great time to be an American tourist abroad. Japan is cheap – my wife and I stayed in a home through Airbnb at $50 a night – and Paris was reasonable. London is still expensive, but they're not on the Euro. Anyway, to date the change is fairly small at 4%, well within the range of volatility of major currencies, and much less than the dollar has strenghthened against the bulk of China's trading partners. [See the previous post on this blog.]

The bottom line is that still leaves them with a stronger yuan relative to a year ago, and certainly relative to 3 years ago. If their intent was to boost their economy, they needed to push the yuan down a lot more!

Furthermore, China is doing what we're asking, liberalizing their markets. Chinese savers (which includes lots of companies that can no longer find investments equal to their cash flow) don't have diversified portfolios. All their assets are domestic, and they are heavy on stocks and real estate and bank deposits that pay 0%. So foreign assets appear very, very attractive, particularly as their stock market crashes. And we're poised to raise rates, while longer-maturity Chinese rates are falling (not that the average saver can tap longer-term markets). So if you were Chinese where would you park your savings? at home in yuan? No, overseas in dollars!! So with everyone wanting to buy dollars, of course the price of the dollar rises and that of the yuan falls. (Given the lack of experience of players in China's markets, that also gives rise to a trend of a falling yuan that gives all the more encouragement for trend-driven Chinese investors to buy dollars while the getting is good.)

For my Econ 398 students: Rudi Dornbush explored this in one of the early rational expectations macro models, though we'd have to devote a couple class days to and likely won't spend much time on open economy issues.

China: yuan depreciation or dollar appreciation?

by Mike Smitka, Economics, Washington and Lee University

The coverage I've read focuses, implicitly or explicitly, on the RMB [yuan 元] / US$ rate, that is, the bilateral context. (An exception is the graph in the latest Economist article, The Devaluation of the Yuan: The Battle of Midpoint, 15 Aug 2015, 63). Their focus is however capital flows, which as I've blogged about before in "China's Pending Depreciation" [on this blog] and "Foreign Exchange Controls" [on my Econ 274 "China's Economy" class blog] will lead to a fall in the value of the yuan – exactly what's happened.

Ho, hum: the 3% change still leaves the yuan stronger than in September 2008

China however trades with the world, not just with the US. Indeed, in 2008-10 [BIS weightings for their trade index, which includes 68 countries] Korea and Japan accounted for 23.8% of China's trade, the Euro area 19.4% and the US 19.0%. More detailed data for 2013 [essentially all countries] show that Japan plus Korea accounted for 14.1% of China's overall trade [imports + exports], the Euro zone at 10.4% [and Europe as a whole at 17.6%], the US at 12.5% [and NAFTA at NAFTA 13.8%], and ASEAN at 10.7%. So while trade with the US matters, Europe as a whole is more important than North America, but it is Asia that really matters.

Let's look at the data. First, the Bank for International Settlements calculates a trade-weighted exchange rate index for 68 countries, and also calculates an inflation-adjusted "real" exchange rate index. (China has had higher inflation that the US, for example, which over time works to appreciate China's currency relative to the nominal dollar rate.) Since the onset of the financial crisis in September 2008 the yuan has risen by 27% in nominal terms, and [the blue line] 32% adjusting for inflation. That has made life significantly more difficult for would-be Chinese exporters, who in labor-intensive sectors such as shoes and garments have not been able to increase productivity. The result is a hollowing out of manufacturing in those areas, with jobs moving to Vietnam and Bangladesh.

Then there are the incendiary headlines, such as Jared Bernstein's "Q&A’s on China’s big currency devaluation" at the Washington Post. I'm sorry, going from 元6.2/US$ to 元6.4/US$ is only a 3% change, not a big devaluation. It's not unusual for the Euro or the Japanese Yen to move that much in the span of a day or two. Furthermore, it still leaves the yuan stronger than it was in September 2008. Ho, hum.

In contrast, over the last 12 months, relative to the US$ the Japanese yen has depreciated by 21.2%, the Euro by 20.6%, the Korean won by 16.3% and the Thai baht by 11.6%. Against that the Chinese yuan has only fallen by 4.3%. Relative to its major trading partners, the Chinese currency hasn't fallen, it's gotten stronger – and that includes the US if we go back before August 2011.

Instead, we should really be viewing this as a dollar appreciation. Our short-term interest rates are poised to rise above zero; those elsewhere remain at or near zero. That makes US assets look attractive, and (tech stocks aside) our stock market also looks sensibly priced relative to (say) China. Thank goodness for China "fixing" its rate, despite $250 billion worth of outflows of "hot" money. Absent such "unfair" behavior, the yuan would surely have depreciated by far more!

Click on graphs to enlarge.

How to Grow a Financial Business: Bubbles vs the Long Haul

I've been struck by the correlation between large shifts in the flow of funds and bubbles, but haven't found data other than for the US and Japan, and those metrics aren't directly comparable. So let me go from the macro(prodential) to the micro behavioral: how can you grow a financial business? There are three ways:

1. provide better service
2. price below competitors
3. take on more risk than competitors

The first provides a sustainable model, exemplified by relationship banking. Because a relationship adds value, at least when backed by comptence, you can charge a premium. As long as you're not greedy, you can also hold onto customers, because there's a sunk cost to a relationship, and creating a new one takes costly time & effort. It's hard to do with large firms, because they need too much money and have too varied of needs. But a good investment bank – think boutiques – can still pull that off. The real niche where this strategy works are community banks, whose customers are too small to play one lender off another, and whose owners/managers have too little time for financial games: they've a business to run. The downside is that a community bank following such a strategy can neither grow quickly nor become too large. That's because from the bank side there's also a resource cost to building and maintaining relationships, and managers need discretion. The first works against growth, while a bank that grows too large needs to systematize lending standards. The really good managers can leave to start their own small banks.

The second strategy is obvious: buying business. That's not so bad when conditions are tight, but that's when bad paper comes to the surface and there are pressures to not grow. So it's really only relevant in an upswing, when volumes are rising but margins are also falling. So to keep growing you have to give money away, and sooner rather than later.

The third aspect, lowering standards, is probably not what a manager pitches to the executive committee, but is a corollary to the second: in order to preserve yields in a business-buying environment, you have to take on greater risk. It helps that in an up cycle risks blur: poorly managed firms do well, or at least well enough. The standard consumer credit rating, their FICO score, just keeps getting better and better as not-very-reliable workers who in a downturn had unsteady income hold onto jobs longer and improve their payment record. You don't need a deliberate game of shading the rating, you just need naivete and optimism on the part of those relying on credit analysis. It helps that those at the working level in finance tend to be young, and don't remember the last down cycle.

My personal experience as a banker was in an up cycle, as the gopher in a team working on eurodollar syndicate loans to Latin America in the late 1970s. Brazil was going to be the next Japan, commodity prices were strong as well, and no one had any experience – the last period of robust international lending ended in 1914. On the surface we were lending to companies for explicit projects, but everything carried a government guarantee, and the Brazilian financiers all came across as competent and experienced, unlike their counterparts in certain other countries.

Margins kept falling, LIBOR + 2%, then LIBOR + 1%, then LIBOR + 0.5%....but we got a management fee, and had funding costs below LIBOR, so that was all right. About the time I was making the decision on whether to head to graduate school I was tasked with calling around to peer institutions to find out the size of their Brazil book and credit ceiling; I had the details for my own bank's position to horse trade. It quickly became clear that all the big players had Brazil paper coming out of every orifice, and were finding it hard to syndicate (unload) onto regional "correspondent" banks, back in the era before interstate banking was allowed. [The only way regional banks could diversify their loan portfolio beyond their local geography was by buying paper from us and our peers.]

Then came Paul Volcker, reflecting Jimmy Carter's determination to tackle inflation. Suddenly commodity prices were falling, Brazil's industrialization strategy hit a wall, and LIBOR peaked at over 20%. On some loans Brazil needed to pay 22% at a time when dollar revenue was plummeting. The big banks managed to tidy over the gap for a couple years, but in effect by mid-1979 the loans that underlay the Latin American debt crisis had already built past the point of no return. My bank managed to survive another decade, but was fatally weakened. Oh, and as ought to be obvious, I decided to head to grad school. Among other things, I'd been the representative for Japanese banks to the IMF-led debt restructuring for Jamaica (also here), an immensely sad experience, and didn't want to do that full-time for Brazil and others.

Meanwhile ... other parts of my bank were making a big push into national accounts (Fortune 100), with similar bad results, while other parts of the US financial system were building up real estate loans, from the entire Savings & Loan sector to big banks like Citi. Had I started elsewhere, I would surely have built up an equally impressive resume printable in red ink. Since then I've been in Japan at the height of their real estate bubble studying urban economics [with hindsight, economics doesn't help much in explaining differential behavior during bubbles], and then was around a couple dot.com executives leading up to the 2000 debacle (on paper I lost a lot of money, but only bought into the market after prices were well below peak). Then there's the more recent real estate cycle, thanks to which I "own" [am beholden to] two houses.

To summarize, growing a financial business quickly is a losing proposition. That such is occurring can perhaps be inferred from the pace of change from old to new sectors in flow-of-funds data. [Still true, in that contingent liabilities are likely underestimated?] If you're looking at a career in finance, and aren't comfortable with making a living forever searching for greater fools, then look for a relationship business. Don't look however to become wealthy.

Employment: tortoise slow, tortoise steady?

Since

Summer 2011 job growth has generally outpaced population growth, adjusting for the retirement of the baby boomers. However, it's a small mountain that we need to climb, given the severity of the Great Recession. As a result, the economy remains several years away from normal levels – an optimistic projection shows we might be back to normal as early as summer 2017. More realistically, we're looking at late 2018 or early 2019, given headwinds to the economy. These include slowing global growth and a strong dollar, and the end of the oil boom, which is hurting investment faster than lower gasoline prices are adding to consumption. In any case, the economy remains 6 million jobs shy of where we need to be. That's reflected in many things, large and small. To give one example, I sit on the board of the local United Way of Rockbridge. We hear that local non-profits that attempt to meet emergency needs for utilities, food and rent see more rather than less need, with more working poor showing up than two years ago: jobs are failing to provide income sufficient to keep up with long-run needs.

Let me reiterate that the economy continues to improve, bit by bit. One indicator that I follow (which underlies the "normal job" level calculation) is the employment to population ratio. This avoids the challenge of counting discouraged workers, which over the past 8 years has swayed the unemployment rate in ways that make it a weak indicator of the job market. Now this participation rate likewise is imperfect as a measure, as it doesn't allow a distinction between part-time and full-time work, and one feature of the Great Recession was a large increase in those put on short hours. The BLS began collecting that data in 1994, and while it peaked at 6% during the depths of the recession, the current 4% rate remains higher than at any point during 1994-late 2008. The third graph provides that data for younger workers. Employment fell by 6% for prime-age workers during the Great Recession. Given noise in the data, it was unclear in spring 2013 that that rate had improved.

During the past two years, however, the share working has clearly been recovering, though it is still 3% below normal levels. The exception is among the young. Some 8% of those age 20-24 have yet to start their work-lives, relative to the stable rate prior to the Great Recession. While according to annual data from the BLS the majority of the difference appears to be accounted for by an increase of those in school, from 8-9% prior to the Great Recession to 13% in 2014. It's unclear to me as an economist what change in the economy would suddenly lead to education becoming more valuable. Instead, it's the opportunity cost that's changed: if (good) jobs aren't available, and in particular if career-oriented entry-level jobs aren't available, there's much less downside to remaining in school. (For those age 16-20 the shift is more dramatic: labor force participation among this group of young Americans fell from roughly 50% to 40%, which is a drop of 10 percentage points (or a 20% decline). Almost all of this appears offset by an increase in schooling. (See the table at the bottom.)

One component of slow growth is the lack of recovery in the housing sector. Now the rate of new housing starts shows a long-run decline, reflecting a decline in the birthrate, the aging of the population and a consequent decrease in the rate of new household formation. I've not tried to model that, and a quick search did not find any papers doing quite what I wanted. It is clear that household formation falls during recessions. For example, FT Alphaville notes the rise in children living with parents; there's no reason to think this is other than a response to the recession. (Kwan Ok Lee & Gary Painter (2013) "What happens to household formation in a recession? Journal of Urban Economics 76:1, 93-109 model this statistically.) What is clear is that housing starts remain very low and for the last year have shown no tendency to rise. So not only construction jobs but housing-related consumer durables suffer.

Will this component of our economy rebound, and offset the headwinds? Theory is unclear, as there are many margins of adjustment, tied to incomes of the young but also the age composition of the population, shifts in the nature of rental housing, and the price of owner-occupied housing. The empirical record is one of volatility. So there's no grounds that I can see for projecting change.

Finally, all this ties into interest rate policy. There's a 6 month lag between a change in interest rates and the start of the impact of higher rates on the economy, and the full impact is not felt for 12-18 months. If the economy will normalize in 24 months, then the Fed needs to start gradually raising interest rates later this year. Given the tendency of the Fed to move in increments of 25 basis points and FOMC meetings generating roughly 8 decision points per year, a 2016 start could lead to short-term rates of 2.5% by sometime in 2017. But if my analysis is accurate, we are still 3-4 years out, and there's no rush. Since it's easier to use monetary policy quell inflation than to spur growth, that reinforces the argument for delay: if you have to make a mistake, it's better to be too late than too early.

	Age 16-20			Age 21-25
Year	Labor Force Participation Rate	In School or Training	Either Work or School	Labor Force Participation Rate	In School or Training	Either Work or School
1998	56.2	31.0	87.3	80.3	7.6	87.7
1999	55.6	31.8	87.4	79.8	7.8	87.6
2000	56.0	32.1	88.1	80.0	7.5	87.5
2001	54.0	34.0	88.0	79.4	7.9	87.3
2002	51.8	35.9	87.7	79.1	8.3	87.4
2003	49.4	38.7	88.1	77.8	9.0	86.9
2004	48.7	39.3	88.0	77.4	9.4	86.8
2005	48.6	39.2	87.8	77.1	9.1	86.3
2006	48.5	40.1	88.5	77.4	9.5	87.0
2007	46.3	42.1	88.4	77.5	9.6	87.1
2008	45.5	43.0	88.5	77.2	10.0	87.2
2009	42.8	44.9	87.7	76.3	10.4	86.6
2010	40.7	46.9	87.6	75.1	11.4	86.5
2011	40.1	47.8	87.9	74.7	11.9	86.6
2012	39.9	47.8	87.7	74.3	12.2	86.5
2013	39.8	48.1	87.9	74.0	12.1	86.2
2014	36.0	53.2	89.2	73.2	13.3	86.5

Lambo: A Rampage of Conspicuous Consumption

mike smitka

If vehicles were purely practical devices to get from point A to point B then car enthusiasts would not exist. Colors? – everything would be gray, easier than white but cooler and less prone to showing dirt than black. Acceleration? – why? Comfort, yes, critical for the commuter, and autonomous cruise control would be part of every vehicle, overriding any attempt at aggressive driving while eliminating rear-end collisions. Perhaps seats could be customized for those unusually tall or short, or for the minority with trim physiques. Sizes, well, there surely would need to be a range, from 2-seat commuters to soccer mom SUVs. And cost! – without superfluous variety, engineering and tooling would be spread across production runs of a few million, while advertising would be unnecessary. There'd be no need to maintain much inventory in the system, either -- in contrast to the 60+ days of inventory in the system today, and the megadealer with 300 vehicles on their and hundreds more off-site. Repairs would be cheaper, and so would insurance, so depreciation aside, the cost of ownership would be lower. Used cars would likewise be a commodity, carrying a minimal markup, and easy to sell.

Linked from the Lamborghini Museum web site

Think VW Beetle, and the underlying vision of a "Volkswagen", a People's Car or Kokumin-sha / Guomin-che (国民車) that bureaucrats in China or India or Japan or Russia made the focus of their industrial policy. Fortunately (?!) for consumers, in the long run these bureaucrats failed to get their way, while in Germany Fordwerke and Opel [and later BMW and Mercedes] provided alternatives. In the US you have perhaps 600 new models to choose from, and even more in China. Europe is surely similar.

The reality is that "our" motor is a status symbol, a statement of personality, a consumption good independent of its value as transport. Indeed, this is central to the industry's business model: profits depend on it.

So let's contemplate the opposite end from that of quotidian transport, a vehicle as a pure status symbol, a la Thorstein Veblen.

Think Lamborghini.^Note What matters isn't the vehicle itself, but that you have one.

First, such a vehicle has to be visually distinctive. That doesn't mean pretty. The Prius succeeded in the US because of its cult status, not because of its value proposition, as its fuel efficiency is far short of what would be required to justify its price. But to gain that status, you had to know what it was, and it was ugly. To reiterate: being ugly was absolutely critical to its success. No one copied the styling. No one wanted to! But while Toyota later offered other hybrids, at markups lower than that for the Prius, those were all versions of existing models indistinguishable from the plain gas version. None sold. Supercars are even more visibly distinctive. By happenstance, and unlike the Prius, some of them are also beautiful.

Second, as a pure status good a vehicle has to have exclusivity. That means price. A Prius is partly an affirmative purchase, commensurate with the self-image of a Yuppie with a social conscious, owned by many with similar affinities. Toyota can and does charge a premium: it sells mainly the loaded trim Levels IV & V, in contrast to the subtle message that it's an economical vehicle, not an extravagance. So it's not exclusive, though also not what a sensible person on a tight budget would purchase. There's no doubt though that a Lambo is a wildly expensive, in-your-face, I-can-afford-it drive.

Third, it helps if the status good at hand is, well, not very good. Let's face it: a Lambo is impractical, verging on useless. It's small, noisy, uncomfortable, and requires a modicum of attention to what you're doing. Texting while driving??? - no way. It's not good for a quick shopping trip, not good for a long drive, and (if you have performance tires) not good in inclement weather. Let's not even think about insurance and maintenance, because it's a statement that you have the wherewithal to own an expensive vehicle that sits in a garage 99+% of the time, with something else as your daily drive. A supercar wouldn't have the same cachet if the designers made compromises – a bit of soundproofing? – to make it a practical vehicle.

So to what extent is your drive visibly distinctive, overpriced and impractical? Surely almost every vehicle has a bit of that, including the '88 Chevy truck that sits in my drive for a week or more between uses, but lets me blend better in my neck of the woods even though I don't have it up on blocks. [OK, for two months I lent it as a daily work vehicle to a friend who is a contractor…it isn't a practical vehicle for me.]. We – even I – care about status. We also care about having consumer products that fit our self-image, and that fit our neighborhood. Both, of course, are obvious sub-texts in car ads.

A Lambo, though, is pure conspicuous consumption.

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Note: I would have used a Porsche 911 as an example, except that, while acknowledging how impractical it is, it's the daily drive of one former student.

Elephants in the Room! Startling New Studies Revealed!

ruggles/Wards

Two important automotive conferences were held in New York City recently in conjunction with the New York International Auto Show. The first conference was the J. D. Power Automotive Forum, followed the next day by the Driving Sales President's Club Event. The conferences had at least one thing in common. They both were launching points for two new surveys regarding what consumers supposedly want in their retail shopping experience, based on consumers answering questions to survey questions. AutoTrader released its new survey at the Power conference while Driving Sales revealed its own survey the next day at their own conference. The presentations of these survey results were rife with anecdotes. Both "studies" "proved" what some people have been trying to prove for decades, that consumers prefer not to negotiate and don't like the sales process.

...the continuation of attempts to predict auto buying behavior by asking survey questions instead of observing actions...

I was reminded of the infamous J. D. Power survey released at the NADA convention in 1993, where they showed that consumers didn't like to negotiate, which "proved" that the Saturn way of doing business was going to take over auto retail. Interestingly, J.D. Power was also selling consulting and training services to teach dealers how to implement the "new sales strategy." At the time, Saturn dealers were doing really well while GM was losing about $1500 per vehicle. Unfortunately for J. D. Power, no one taught the OEMs that for the "Saturn Method" to work over production can't be part of the equation and true "success" includes OEM profit. [The Prof adds: in the pre-internet days Saturn dealerships were also few in number and widely dispersed, which was important in limiting the ability of consumers to play dealerships off against one another]

At the same 1993 NADA convention new research was published by an Arizona research and marketing company that showed the exact opposite of what the Power survey had said. The different results were achieved by merely changing the wording of survey questions. At the time it seems that consumers really do want to negotiate, they just want to be guaranteed a win. They want to play poker with you. They just want to see your cards first before placing bets.

The marketplace ultimately proved who was right and who was wrong. Saturn proved many things. It proved that fresh product enthusiastically received by the consuming public is essential. And we know GM subsequently starved Saturn for product. After all, why give a division product unless they have proven they can move the metal? Saturn proved that some consumers prefer their business model. They also proved there aren't enough of them to make for a viable division. Saturn introduced a stellar vehicle in the Aura. Yet, consumers voted with their feet. Instead of buying the very competitive Aura and its consumer friendly sales model, they went in hordes to Toyota and Honda to get abused by the so called traditional sales model. Go figure.

Later in the decade Ford attempted to show the industry how to do auto retail based on how consumers respond to survey questions. The Ford Collection lost hundreds of millions of dollars and was one element of the underlying dissatisfaction that cost Ford CEO Jacque Nassar his job. [The Prof adds: the Explorer-Firestone rollover issue was a factor, too]

Both of this year's surveys ignored some "elephants in the room." While demonizing the "old methods," as if there is such a single thing, they failed to tell us exactly how to do what consumers want us to do while still making money. After all, new cars aren't sold for profit these days anyway. Dealers typically pay off more at their floor plan lender than the customer just paid for their new vehicle. And after paying each new vehicle's share of the overhead, our industry is selling new vehicles for about break even. And to add insult to injury, consumers still aren't happy.

I'm living proof that there is no such thing as the "old method" of selling new vehicles. I started in the business in 1970, selling in a One Price store, although it wasn't called that back in the day. We called ourselves "Moral Motors." The anecdotes related by those who try to demonize "the old ways" might describe some stores, but they certainly don't describe them all. There has never been a single way for dealers to run their sales operations. Auto retail has ALWAYS been about relationships and satisfying customers. This has never changed. As a consultant/ trainer over 20 years ago, we taught sales people to open dialogue with prospects by saying, “Before you leave, we want to make sure we provide all the information you need to make a practical purchase decision, including some numbers to think about.” Today that's called "transparency."

Even though the consumer today has ready access to all sorts of information, they "know" less today than they ever did because of the complexity that exists today. Much of that complexity was created by OEMs when they curtailed dealer markup and hid gross profit behind invoice, something I seriously doubt consumers would call “increased transparency.” The vast amount of information available today is like drinking from a fire hose for consumers. Auto buying consumers have more information, yet know less. Over the last few years I have visited hundreds of dealerships. I have seen a consistent pattern of sales people attempting to deal with consumers who think they know a lot more than they do. It is an art to correct your potential buyer on their misconceptions while still maintaining a relationship to allow them to do business with you afterward. Many of our sales people fail miserably at this. [The Prof adds: with sales staff turnover, don't be too sure consumers aren't the more informed party! But remember too brand proliferation: can you name all 600 makes on sale in the US market??]

I am able to do my own research. Since it is informal I don't try to calculate a "margin of error" or use lofty terms to describe my methodology. I am regularly in front of groups of college students. My own personal study group is my 22 Gen Y nieces and nephews. Further, I am regularly in front of a large group of retired millionaires at a retiree forum in my home town. This gives me the opportunity to conduct show of hands type surveys. Example: "How many of you think an auto dealer is entitled to a return of 10% on the sale of a new vehicle?" EVERYONE in the room raises their hand. A little later I'll ask, "How many of you, after you get home after buying a new car, would be upset if you find out you paid the dealer a $3K profit." EVERYONE in the room again raises their hand!!

For those who think the Ford Collection, Saturn, and Priceline outcomes happened ages ago and are no longer valid, a Dallas company specializing in lease comparison software, Cybercalc.com, recently did extensive surveying which “proved” consumers prefer to get their deal structured and “locked in” before revealing who their identity. The initiative was called AutoBids Online and a small fortune was invested to create a software platform to enable consumers to anonymously enter a marketplace where dealers would bid for their business, thereby locking in an offer before the consumer’s identity was revealed. This would seem to prove that the AutoTrader survey results on this issue are valid, right? In talking to CyberCalc CEO Jeff Cook about his expensive lesson as it regards auto buying consumers, he says, “I have some GREAT software for sale if anyone thinks the market is now ready for this. When we did this a few years ago, it clearly wasn’t, despite our extensive surveying.” Perhaps it was the $29 consumers had to pay top enter the marketplace? One would think that would be a small price to pay for avoiding the “old method grind,” right?

This is not to say that the Internet hasn’t forever changed some things about our business. Dale Pollak and others have definitively proven that if a dealer prices his/her vehicles wrong, their inventory will never be seen by consumers doing routine searches. But this has been proven by actual consumer behavior, not by surveys.

So what are the "elephants in the room" ignored by these recent surveys? In our bid to thrill consumers shouldn't we ask them about how we answer the phone? After all, a HIGHLY valued relic from the past, Jackie B. Cooper, used to point out that the dealership telephone operator talks to more potential gross profit than any employee in the dealership. "And who gets paid the least?" Jackie would ask. These days the telephones are answered by an IVR system (Interactive Voice Response). en Y calls them "bots." AND they are universally reviled. Why are no studies focused on how our customers like the way we answer the phone?

Another elephant? Even the best sales process can turn counterproductive when executed crudely. The least polished of our sales people make up the VAST majority these days. Why? Because WE have run off most of the good talent. Our industry has cut the upfront markup, increased the holdback, increased the pack, taken away demos, cut fringe benefits, instituted full retail markup internal charges, etc., etc., and we wonder why we are left with the unpolished and unpracticed sales people? When you turn over employees it is because you either did a bad job of hiring, or a bad job of managing. Why ignore this while focusing on peripheral issues?

Perhaps the most outlandish claim "proven" by the Driving Sales survey is that our industry is losing up to 5 million new vehicles sales each year because consumers don't like our processes. This is referred to as lost "headroom." This assumes that consumers who don't like the first dealer they encounter, exit the market instead of exiting that dealership and visiting another. I have run this claim by a number of industry economists. I first started asking about "lost SAAR" when I heard TrueCar's Scott Painter claim that new vehicle retail could be doing 20 million SAAR if we eliminated the "friction" in the sales process. The unanimous responses from these numerous industry economists and other experts uses terminology reminiscent of Norman Schwartkop's reference to "bovine scatology."

At least we all got to listen to Warren Buffet and Larry van Tuyl at the J. D. Power conference and Maryann Keller at Driving Sales. Maybe it’s just that I take comfort in listening to common sense from people closer to my age bracket, or maybe I just like listening to common sense from whomever it comes from.

Some high points, or low points of the conferences, depending on one’s perspective follow. According to the AutoTrader study:

Consumers want a change in the car buying process, but they failed to define either “old process” or “new process.”

There is no such thing as “the old process.” Dealers used to compete with other dealers to provide an experience acceptable enough to consumers to gain their fair share of sales and gross profit. It seems like any new process would work the same way. If there is a single universally acceptable new process that would accommodate the 30% of buyers who are in the Buy Here/Pay Here or subprime credit category, as well as the near prime tiers, and would take negative trade equity into consideration, as well as “fast track” credit buyers, AND allow for dealer Return on Investment, we’d all like to hear about it.

Consumers want to test drive new vehicles at a central location without sales people present.

What they failed to ask is how much more consumers would be willing to pay for this.

Consumers dislike the process as it is today...

...yet that process sells 14 million plus new retail units per year. Perhaps consumers would prefer if the FTC would allow dealers to fix prices so everyone could pay the same price? Why not ask consumers how they would like that?

Consumers prefer to remain anonymous until they lock in a deal.

Of course they do. So what?

Dealers have always been free to adapt to whatever they believe consumers really want.

A lot of money has been invested in attempts to do business based on what consumers say they want in surveys with Saturn and The Ford Collection being the best examples. Maryann Keller mentioned the Priceline experiment, which didn’t work. She should know. She ran it and is completely upfront about the experience. Who better to tell us about the difference between what consumers say and how they actually behave than the world’s leading auto analyst who also spearheaded a well financed attempt to appeal to consumers based on their stated preferences? What has changed since those expensive experiments failed? Why are people still continuing to try to prove that consumers behave the way they say they would on surveys?

From Driving Sales: Rachel Richards, listed as Vice President and Chief Marketing Officer from Sonic Automotive, the country’s fourth largest automotive retailer, gave a presentation on their new retail initiatives called “One Sonic - One Experience.”

One would think that Richard’s previous career experience with Ford Motor Company might have provided some insight on the difference between what consumers say on surveys and how they actually behave in the real world. As I understand it, the new program is still in pilot stage and has not been rolled out across their system. My understanding is that they have 15 sales people at one pilot store who also do their own F&I. When I asked if they would all be AFIP (Association of Finance and Insurance Professionals) certified, she told me she didn’t know what that is, and that a different department was responsible for the F&I element. I can only imagine the regulatory vulnerability associated with having 15 sales people all trying to do their own F&I. I’m sure time will tell, as it did with the Ford Collection.

What seems to be inevitable is the continuation of attempts by some to predict consumer auto buying behavior by asking them survey questions instead of merely observing their actions. After all, we have many talented and experienced experts who are in the trenches on a daily basis. Why not just ask them?

Notes from the International Car Rental Show April 2015

Ruggles/Wards/Bobit Media

I was recently privileged to attend the International Car Rental Show, held at Bally’s Las Vegas. I have attended this show in previous years and always came away with something noteworthy. This year, for the first time, the show included a break out track for auto dealers. While my primary interest was keeping up with all things car rental as they impact residual values going forward, I felt compelled to attend the car dealer sessions. And was I in for a shock.

It turns out that many things I thought were settled, aren’t. It seems that many dealers still send their customers to 3rd party car rental companies for loaners and rentals, even when the rental is being paid for by warranty or a service contract sold by the the dealership. Last I knew these third party car renters also sell used cars. Shouldn’t those car renters be paying dealers for introducing them to new prospects, not the other way around. A dealer doing a good job selling service contracts should be penetrating at least 60%. That’s a lot of rental car days paid for and the customer is as happy as if the dealer actually paid for their “loaner.”. Why send that revenue stream elsewhere? It turns out that many dealerships are too lazy to “do the paperwork” each time they roll a car on a rental or policy adjustment “loaner.” After all, if the rental car isn’t charged out to a specific department, a service contract company, policy adjustment, or to the customer, the sense that the car rental business doesn’t make money takes over the dealership.

What does it cost to NOT have a rental car operation? What does it cost the dealer when he/she is at the end of a stair step program and needs a few unit sales to reach a plateau, especially one that is retroactive? What does it cost to not have those units registered in your market for MSR (Minimum Sales Requirement) purposes? What does it cost to not have off rental units available as organic pedigreed pre-owned inventory and you have to go out and buy inventory at wholesale? What does it cost for the lost pre-owned sales when third party renters sell YOUR customer a pre-owned vehicle because YOU introduced them? What does it cost when your customer becomes impatient at the time it spends to be transported to the third party car renter. What happens when you customer has a beef with your third party car rental company?

I discovered there are still dealers who hang a dealer plate on a piece of used vehicle inventory and put it out as a loaner. What does that cost? What are the insurance ramifications?

Well, I found out a lot of things at this most valuable conference. I found out that despite the fact that dealer garage keeper liability carriers have policies for rental units, they tend to NOT accept a mixture of DRAC (Dealer Rental Car) units and rental units they insure. I also discovered that there is an increase in guaranteed value rental units, known as factory program vehicles as opposed to rental risk units. This allows automotive OEMs to have better control of rental units and cycle them when it benefits them. This could be the beginning of some of the bad behavior that caused used vehicle values to crater in years past, especially with the tidal wave of off lease vehicles heading our way in the next few months.

Bottom Line: This was a VERY beneficial conference to attend and one I highly recommend to auto dealers now that the break out track sessions for dealers exists.

Pardon the Sarcasm

ruggles/Wards

I am astonished that the new “hot trend” in auto retail is thinking that a car deal should be accomplished in an hour or so. Hell, it takes almost that long to explain how the infotainment system works, let alone the other gadgets in a new vehicle.

How long does it take to go over all of the forms demanded by government regulation, or do we just have the customer sign them without reading them? After all, we want our customers to be happy, right?

If you sell “product,” there are forms associated with those too. Or perhaps we should give up selling product because the most important thing is speed? If you sell product, you’d better damn well get declination forms signed or you’ll eventually find yourself in all sorts of hot water. And those take time too.

However, there is no doubt that on a busy day, we might not be staffed to handle buyers expeditiously if those darn consumers decide to buy in bunches instead of evenly spacing themselves.

It IS possible to do most of the deal with some customers before they come to the showroom IF the deal has no complications or hair on it. They keyword in the previous sentence is “some.”

If time is the most important element we could send all of the tough deals down the road to competitors to keep our average elapsed average time low. We could limit customers to credit scores of say 680 and above and send the other ones packing. Those low credit scores take much too long and would ruin our average. And about those people with negative equity, who have no cash, a false vision of what their trade is worth, and want to buy way more than any lender would advance... what do we do with them? They fewer of these we have the more likely we can average one hour transaction. There! Problem solved.

I thought our business was still about gross profit. I thought our mission is not so much to give the consumer what they want, but to get them to like what we give them. Of course, we want the highest customer satisfaction possible. We also want and need repeat business and referrals. But let’s stop with the silliness.

The 6 Fluids

As a car owner, the best thing that you can do for your vehicle is to keep it properly maintained. You don’t need a mechanic to check the fluids in your engine, nor do you need a degree to be able to top them off when necessary. By taking a few simple measures and making sure that these six fluids are within proper levels, you can prolong the life of your car. Your owner’s manual will have everything you need to know about maintenance schedules and recommended fluids. For a great running vehicle, here are the six automotive fluids you shouldn’t forget to check.

Motor Oil

This fluid is essential to any internal combustion engine. The purpose of motor oil is to lubricate parts. Oil also prevents rust from forming inside your engine by blocking oxygen from reaching the metal. It even takes particles out of your engine and deposits them in the oil filter, keeping your engine clean. If oil is too old or gunky, the engine will start to destroy itself. If it goes on too long, the engine will completely lock up and become useless.

Outside of gasoline, motor oil is the most important automotive fluid. Most of us learned how to check the oil when we got our first cars. Whether that time was decades ago or just a few days ago, the process is pretty much the same. Open the hood, pull up the oil dipstick and wipe it clean. Then dip it again and pull it out and you'll see your oil level. If it's below the safe level, then just add more. Get it completely changed every so often depending on how much you drive and the mileage rating for your oil.

Transmission Fluid

Like motor oil, transmission fluid provides lubrication and cooling to the transmission. Automatic transmissions also use transmission fluid to provide the hydraulic pressure necessary to shift gears. Unlike motor oil, the level of transmission fluid should never change unless there’s a problem.

Mechanics look at the quality of the transmission fluid. It should be red in color and not smell burned. If it has a burnt smell to it or has turned brown, it's time to change your transmission fluid. This should be checked about once a month.

Coolant

Sometimes known by its other name, antifreeze, coolant transfers heat away from the engine around so nothing gets too hot or too cold. It moves from the engine to a radiator where the heat can be dispersed safely. If your coolant level gets too low, the car will overheat. Coolant mix is normally a light green color.

Coolant is usually a 50/50 water and antifreeze mix, for those cold winter days (and nights). Antifreeze lowers the freezing temperature of water so the inside of your car doesn't become a block of ice. Remember when changing coolant that your car needs to be cold so there is no steam inside the system.

Washer Fluid

While your car won't break down without washer fluid, you will definitely miss it if you run low. Without it, your windshield wipers will just smear around dust or bugs or whatever else happens to be currently blocking your view of the world outside. Washer fluid is basically liquid soap, but that doesn't mean it can be replaced with soap and water. It also contains special ingredients that help dissolve any bugs stuck to the glass and lower the freezing temperature of water so your washer fluid won't solidify if you happen to live in a place with cold winters. Washer fluid is normally a bright blue color.

Brake Fluid

Brake fluid is absolutely essential. It is used to create hydraulic pressure which forces your car to stop. If your brake fluid starts leaking or air gets into the brake line, it will get a lot harder to bring your vehicle to a stop. Like transmission fluid, brake fluid is part of a closed system. If you find that your fluid is leaking, it’s best to take your vehicle to a mechanic rather than try to replace it yourself.

However, you can check the quality of the fluid yourself. You can check the brake fluid reservoir every time you check your oil levels. So long as your brake fluid looks golden, it's good. If it’s brown, it’s time to have it replaced by a certified technician.

Power Steering Fluid

Power steering fluid not only lubricates the steering mechanism, but it uses hydraulic pressure to help turn your vehicle. When it starts to run low, you’ll most likely hear it when you start to turn the wheel. Strange noises or difficulty in steering is an indication to take a look at the levels of power steering fluid. Check the reservoir. If it looks like it’s running low, then take your vehicle to a mechanic.

While these fluids remain quietly working in the background, they are vital to the operation of your vehicle. Pop the hood and check them every once in a while to try to catch any possible problems when they’re small. Keeping these maintained will keep your car running smoothly for years to come.

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Emily Hunter is a SEM Strategist and Outreach Supervisor at the Marketing Zen Group and is working closely with ZAK Products. She loves designing strategies with her team and is excited about spreading the Zen gospel. In her spare time, she cheers for Carolina Crown and Phantom Regiment, crafts her own sodas, and crushes tower defense games. Follow her on Twitter at @Emily2Zen

The PACE of Automotive Innovation

Suppliers are integral to new technology in the auto industry to an extent not true since the early years of the 20th century, when ventures such as Ford began as mere assemblers, not manufacturers. That will be highlighted on Monday, at the 21st PACE "academy awards" for supplier innovation. (For those not in the know, Monday's the opening night of the SAE [Society of Automotive Engineers] in Detroit.)

Caveat lector: your not-so-humble author has been a judge from the competition's beginning.

General Motors began as a conglomeration of existing firms, both suppliers and assemblers. As it grew – and as Ford stumbled – it added more suppliers while dropping brands. By the 1960s it was highly integrated, with suppliers relegated to trying to make parts to GM's blueprints. Now that strategy had unintended consequences, as the route to the top became finance, with other functions such as making and selling cars treated as an afterthought. Be that as it may, come the 1970s, first emissions controls, then fuel efficiency mandates, and finally safety regulations forced car firms to engage with non-traditional, outside suppliers. Meanwhile, new entry meant that the comfortable Big Three oligopoly could no longer ignore the challenge of actually making and selling cars. One response was to spin off internal parts operations, and with it the ability to do the relevant component-specific R&D. Finally, alongside this demand-side story were two technology revolutions, those of materials science and of electronics and sensors that enabled these suppliers to turn to innovation as a way to build their businesses and preserve margins. The bottom line was that suppliers became central to automotive innovation.

This supplier-centric industry has lots of implications. For one, it may facilitate new entry; Aptera, Fisker, BYD, Chery, Geely, Great Wall, Tesla, Bright Automotive, Edison2 and others could buy drivetrains, transmissions, sensors and controls from existing, auto-tech-savvy suppliers. Not all have survived, due to a combination of undercapitalization, poor product strategy and bad luck. However none could have started had suppliers not controlled – and built their businesses around selling – core technologies. Exploring such implications, including for investors, is however a topic for subsequent posts.

Here let me briefly note the role of suppliers, using engines are an example. (My apologies to Europeans for focusing on gasoline rather than diesel engines.) Drawing from among PACE award winners, we see the following areas dominated by suppliers: fuel tanks, fuel pumps, fuel vapor recovery, injectors, injector electronics, spark plugs, valves, camshafts, pistons, piston rings, bearings, seals, sensors of many types, turbochargers and turbocharger escape valve technologies. There are other areas (engine block castings, machining) where car companies continue to dominate, but even there suppliers provide the machine tools that are critical to these operations. In short, while car companies may work on the configuration of the engine and the integration of these various components, the advances come from supplier technology.

It's not just engines. A wide array of vehicle systems are dominated entirely by suppliers, such as clutch components, transmissions, differentials and driveshafts, HVAC systems, lighting, ESC systems, tires, tire sensors, suspensions, ECUs and most other sensors and vehicle electronics, airbags, seatbelts, hot stamping, hydroforming, paints, structural adhesives, sound-proofing materials, water pumps, radiators, headliners, instrument panel surfaces and underfoams, starter/alternator systems, belt and pulley systems, timing chains, windshields and glass, wiper motors, wiper blades, radar, lidar and ultrasound sensors, cameras and image recognition systems, infotainments systems, and on and on. More important for Monday, you can find examples among the two decades of PACE finalists and award winners.

I've been privileged to judge this competition since its inception, thanks to the entre provided by my own research (my PhD dissertation was on automotive suppliers in Japan). As a result I've been able to visit 2-4 suppliers a year for in-depth presentations on technologies and their business case, and to sit with the judging panel to hear their summaries of similar visits. Along the way I've earned my PE degree as well. [P.E = pretend engineer] Now the entire process is under NDLs (non-disclosure agreements) so I have to be careful, but I have tried my hand (with co-author Peter Warrian) at analyzing the finalists using publicly available information for lessons on technology. You can find our initial paper here and a more recent analysis (incorporating 2015 finalists) here. photo: Federal Mogul's IROX engine bearing

Anyway, watch Monday night for the stream of press releases from the winners, and the Automotive News coverage of the entire award ceremony. I'll be there, in my tuxedo, enjoying the food and drink, and the celebration of innovation. It's a fun and thought-provoking event!

China's Pending Depreciation

As I prepare to begin grading final exams from my course on China's economy, let me start a series of posts stemming from my teaching this term, and from a lecture (ppt here) that I prepared for the Asian Studies program at James Madison University to my north, in Harrisonburg VA. (It's also my son's alma mater.) Here I focus on China's exchange rate.

China, as typical of many developing countries including in their day Japan and South Korea, engaged in financial repression, holding bank deposit interest rates low so as to hold bank lending rates low and thus to encourage investment. As initially capital-poor economies there's a certain logic to this, and it fit with the 1950s-1960s model of "Big Push" industrialization. This of course transfers resources from savers, who earn little on their accounts (often less than inflation), to investors. Maintaining the policy requires closing off foreign capital markets to domestic savers (and was typically accompanied by an exchange rate pegged to the US$). It also required restricting domestic options that would allow disintermediation. (In Japan, for example, domestic bond issues were severely restricted, and various policies discouraged the growth of the stock market.)

The early empirical work of Phyllis Deane and others on the British industrial revolution – with better data, now known to be wrong – seemed to show that it was accompanied by a big upturn in investment. That flawed view was carried over to W.W. Rostow's 1960 book, The Stages of Economic Growth: A Non-Communist Manifesto [which in fact employed a Marxist framework!], and was taken up across the "developing" world.

One side effect is the growth of "shadow" finance, and a quest for real assets that might offer returns commensurate with real GDP growth. (Think real estate!) That and related distortions are a topic for a later post. Here I focus on another side effect, undiversified portfolios.

Japan's case is a good example. As of the late 1970s, Japanese life insurers sat on a portfolio comprised of domestic stocks and long-term corporate loans (plus a dollop of primarily JGBs, government bonds). The issuers of these assets – and the people for whom they'd sold life insurance policies – also sat on top of a major tectonic fault, the source of the earthquake that leveled Tokyo in 1923, killing 110,000 people. They obviously had an incentive to diversify their investment portfolio against the next Big One. As Japan moved toward financial market liberalization (with major legislation passed in 1980), these insurers were initially allowed to move 5% of their portfolio into British and US government bonds. The timing was great: the initial handful of staff in London and New York bought bonds just before interest rates fell in those markets, generating wonderful returns that were amplified by a massive capital outflow that caused the yen to depreciate, giving them even better returns [my memory is that the first set of investments earned 50% – and being sent to open these overseas offices was already a signal that those people were on the radar screen of top management as up-and-coming executives]. To reiterate, the bottom line was capital outflow and yen depreciation: the yen briefly strengthened to Y180/US$ in 1978 fell to an average of ¥230/US$. Capital outflows eventually slowed (and US interest rates fell), and the yen began slowly appreciating (from ¥260 in February 1985 to ¥230 in September) and then shot up following the Plaza Accord to peak at ¥120 in December 1987 (by which time Japan's domestic real estate and stock market bubbles were building, another legacy of the end of financial repression).

China is poised to repeat Japan's experience. Shadow financing is collapsing; tales of ponzi schemes and other frothy behavior are rife. The stock market is ... stratospheric. Real estate prices are falling. And US interest rates are poised to rise. Furthermore, while the RMB has depreciated slightly against the US$ (the red line in the chart), the appreciation of the dollar against the Japanese yen and the Euro means that the "real" RMB (the blue line in the chart) has actually appreciated relative to its trading partners – to China the Euro zone matters slightly more than the US. This is the setting for a perfect storm, a scramble for the exit, which means the US dollar. If Japan's experience is any guide, the shift could be large (Japan's was 50%) and last for a half-decade.

Jeffrey Frankel points to evidence that the race for dollar assets is underway (his full blog post here, and his Project Syndicate post). China's foreign reserves are down from their peak (US$3.99 trillion to US$3.84 trillion, despite a continuing trade surplus), a current account outflow, with the Bank of China selling dollar assets to domestic holders of RMB. Absent this additional supply of dollars, the value of the dollar would rise – I append a basic S&D graph to illustrate the impact of this intervention.

As I've long warned [an earlier post], Congress should be careful what they ask for. If the Chinese stop intervening, all the forces point towards depreciation!