America's carmakers make a comeback

Rinsed and raring to go

After a terrible year there are signs of hope for Detroit

AMERICA’S carmakers appear to have returned from the grave. This week the three big ones—Ford, General Motors and Chrysler—all had good news to report. Ford recorded a wholly unexpected profit for the third quarter of nearly $1 billion, thanks in large part to a huge improvement in its North American operations. Sergio Marchionne, boss of Fiat and now Chrysler, laid out a detailed five-year plan for restoring the American company to health in a seven-hour presentation. Most sensationally, GM’s board, citing both the improving business environment and the firm’s own recovering financial health, reversed its decision to sell a majority stake in Opel/Vauxhall, its European subsidiary, to Magna International, an Austrian-Canadian partsmaker, and Sberbank, a Russian bank. Both GM and Ford were also able to post year-on-year increases in sales in October, of 4.7% and 3.3% respectively.

A year ago, such a turnaround seemed unimaginable. GM had declared losses of $4.2 billion in the third quarter and Ford of $2.7 billion. Both firms had burned their way through nearly $7 billion of cash each during the quarter. The smallest of the three, privately held Chrysler, did not say how much it had lost, but an educated guess was about $2 billion.

The rest is history. The government stepped in to prevent a potentially catastrophic collapse of GM and Chrysler with $62 billion of Treasury loans and then shepherded both firms through “quick-rinse” bankruptcies that shrank their debt, cut the cost of obligations to retired workers and pruned their sprawling dealer networks. Italy’s Fiat was recruited to take over the management of Chrysler and share its advanced technology for small cars in exchange for a 20% stake. Ford struggled on, completing its restructuring without help either from the taxpayer or bankruptcy, thanks to the $23.6 billion it had raised in 2006, before the credit markets froze, by pledging all its North American assets as collateral.

All three firms will now be helped by what may be a quicker and stronger recovery in car sales, particularly in America, than most people are expecting. It will be a long time before sales return to 17m a year, the level until recently regarded as “normal” by an industry accustomed to pumping up demand with cheap credit and suicidal pricing. But Adam Jonas, an analyst with Morgan Stanley, points out that previous recoveries in car sales have been “V-shaped” (see chart), and that this one is likely to be too.

After sales hit a low this year of only 10.5m, Mr Jonas is forecasting sales of 12.8m next year and 14.5m in 2011. He is relying on the combined effects of broadly based economic recovery, especially in the housing market, and the unprecedented age of the car fleet, which has typically peaked after seven years of consecutive increases in cycles going back to 1970 (the last inflection point was in 2001).

Since emerging from bankruptcy GM and Chrysler have reduced the level of annual sales at which they can break even from more than 16m to 10m. Assuming that neither loses much more market share, both should start making an operating profit next year. Meanwhile Ford’s chief executive, Alan Mulally, said this week that he was changing his guidance for 2011 from break-even to “solidly profitable”.

There the similarities end. Of the three, unquestionably the best performer has been Ford. In America its market share has leapt by 2.2 percentage points over the past year to 14.6%, helped by the acclaim it has earned by avoiding bail-out and bankruptcy and by the good reception given to new models such as the F-150 pickup, the Taurus and the Fusion Hybrid.

However, the decision to forgo the fresh start of bankruptcy means that Ford’s debt will rise to around $35 billion after payments are made to a retired workers’ health-care fund. Ford is also paying a price for its independence in another way. Under the terms of the overhaul of GM and Chrysler in bankruptcy, the autoworkers’ union made substantial cost-cutting concessions in return for a big share of the equity in both companies—concessions that the union this week voted heavily against extending to Ford.

As for GM, fears that bankruptcy might terminally undermine customer loyalty appear to have been overdone. GM’s product portfolio, although some two years behind Ford’s in competitiveness according to Mr Jonas, is steadily improving and has the potential to make a similar turnaround. Better quality, advertising targeted on only four brands and the improvement in used-vehicle values that is coming from no longer chasing volume at all costs should all speed GM’s revival.

The decision not to part with Opel/Vauxhall, although infuriating to the German government and the unions, is a sign of GM’s growing confidence. It had never wanted to sell Opel, which despite being lossmaking is GM’s main repository of expertise in technologies for smaller cars. But it felt it had no option until the European Commission forced the German government to promise that a proposed €4.5 billion ($6.7 billion) loan would be available to any investor, and not just Magna. Keeping Opel will allow GM to mimic Ford, which plans to meet growing demand for small and medium-sized cars by manufacturing in America products first developed in Europe, such as the new Fiesta.

Despite a typically bullish performance by Mr Marchionne on November 4th, doubts about the future of Chrysler will be harder to dispel. In contrast to Ford and GM, Chrysler’s sales last month were 30% down on a year ago. It is hamstrung by an absence of new models and negative reports on the quality of its vehicles.

Perhaps the best news that Mr Marchionne delivered was that Chrysler had $5.7 billion of cash at the end of September, compared with $4 billion when Fiat took over in June, and that it should make a small operating profit next year—testimony to phenomenal cost-cutting in bankruptcy. The relentlessly upbeat presentations by a succession of Chrysler executives (nearly all them new to their posts) provided a road-map of how the partnership with Fiat will transform the company and its ability to develop at speed cars that customers will want to buy.

Together they made Mr Marchionne’s target of doubling worldwide sales to 2.8m by 2014 sound almost achievable. The worry is that there is no quick fix for the lack of new products. For the next couple of years Chrysler will have to rely mainly on facelifts of existing models and urgently-needed improvements in quality. The biggest question is whether that will be enough to lift Chrysler’s market share well above its current 6% before a range of new products based on Fiat’s platforms and powertrains starts to appear in 2012. If Ford and GM are in the recovery ward, Chrysler remains on the critical list, for now at least.

(Source: From The Economist print edition)

Future dreaming

France, Germany and the European Union

French hopes for new Franco-German leadership in Europe may yet founder on disagreements about policies and priorities

TO MOST people, the prospect of an end to the European Union’s institutional navel-gazing is welcome. Once the Czech holdouts ratify the Lisbon treaty, goes the line, there should be no new grand schemes. Yet this is not how things are seen in France. Indeed, the French have been laying the ground for their next big idea: a deepening of the Franco-German axis to entrench their dual leadership and make Europe “one of the principal players of the 21st century”.

In a speech to his ambassadors in August, President Nicolas Sarkozy declared that he wanted “Europe once again to make history instead of enduring it”. His model was “Franco-German understanding” built on his friendship with Angela Merkel, the German chancellor. His Europe minister, Pierre Lellouche, is zealously spreading the message. “More than ever, the relationship between France and Germany will form the heart of what I would call the third phase of post-war European history,” he recently wrote in Le Monde.

The French are not suggesting a new EU treaty, but they have plenty of other wheezes. The celebration with Germany of the 20th anniversary of the fall of the Berlin Wall next month may make up for François Mitterrand’s lack of support for German unification. The French want a joint commemoration of Armistice Day on November 11th. There is talk of marking the 50th anniversary in 2013 of the Elysée treaty on Franco-German co-operation.

Plenty of policy ideas are being kicked around as well. The French want to persuade the Germans to back a new industrial strategy to promote European champions, a common investment in clean technology, a European plan for energy independence, greater tax co-ordination and more. They see common ground in opposition to Turkish membership of the EU, as well as reform of laissez-faire capitalism. There is talk of a joint Franco-German government minister. Mr Lellouche has asked his team to prepare “a new Franco-German agenda for Europe”, ahead of a joint cabinet meeting before the end of the year. “In the new European configuration,” he said last month, “the Franco-German relationship will be central, because only it combines both political will and the capacity to push grands projets forward.”

There are many impulses behind this new Gallic offensive. One is Europe’s changing politics. The French realise that the British are likely to be unhelpful friends if the Eurosceptical Conservatives win the election next spring. “David Cameron makes Maggie Thatcher look like a veritable federalist,” comments one aghast French politician. At the same time, the re-election of Ms Merkel at the head of a centre-right coalition, instead of her former unity government with the Social Democrats, boosts French hopes of a more decisive German government.

Another factor is the view that, when the French and the Germans agree, Europe makes its voice heard. The French list the G20 agreements to curb bank bonuses, strengthen bank capitalisation and squeeze tax havens as examples.
No bridge across the Rhine

As it happens, Mr Sarkozy, never an instinctive Germanophile, got off to a fractious start with Ms Merkel, falling out over French plans for a Mediterranean Union; and it took time for Ms Merkel to get used to Mr Sarkozy’s tactile chumminess. But Mr Sarkozy knows he cannot impose his ideas on Europe. Early on he spotted a chance to use the anti-capitalist mood against the “Anglo-Saxons”, and sought an ally. “There has been a spectacular conceptual rapprochement between Merkel and Sarkozy,” insists a French official.

Yet across the Rhine the preference is for plodding progress rather than grands projets. The German foreign ministry recently held a one-day meeting to discuss relations with France, but there was little debate about Mr Lellouche’s proposals. After all, there is still no new German government in place. The Social Democratic foreign minister, Frank-Walter Steinmeier, will go, but his successor, almost certainly Guido Westerwelle of the Free Democratic Party, has not yet arrived. If Mr Lellouche “honestly wanted his proposal to happen, he wouldn’t have launched it in an article in Le Monde,” noted one Berlin-based observer of Franco-German relations.

Nor is a new golden age likely when Ms Merkel and Mr Westerwelle take office. The EU’s biggest member has acquired a reputation for looking after itself—whether over saving the Opel carmaker or over euro-area bank rescues. Mr Westerwelle’s party will be charier of an activist industrial policy than were the Social Democrats.

Germany has other foreign-policy priorities besides France, such as improved relations with Poland and other central European countries. On nuclear power and Turkish membership of the EU, Ms Merkel’s new government is closer to French positions, although even here agreement may be elusive. It will keep nuclear-power stations open longer, but the two countries may not agree on a lot else over the EU’s energy policy. Nor is it clear that Ms Merkel will want to obstruct membership negotiations with Turkey.

Economic issues may be no easier. Germany’s new balanced-budget amendment to its constitution will force it to pursue a tight fiscal policy, unless the coalition circumvents it to permit tax cuts. France, on the other hand, plans to grow out of its deficit at a leisurely pace. Differences in debt and competitiveness will make it harder to manage the euro area. Germany will preach thrift and reforms to boost competitiveness. But if it just lectures its partners rather than co-ordinating policies, it risks aggravating tensions within the euro group rather than alleviating them.

Nor is there yet a Franco-German agreement on how to take the EU forward after Lisbon. A ruling in the summer by Germany’s constitutional court means the government must consult the legislature more often about EU initiatives. It is not clear if Germany means to give the EU greater scope for action or treat it, as many others do, as the mere servant of national governments. There is no sign of a bilateral deal on the allocation of the senior jobs being created by Lisbon.

The French are not starry-eyed. They know they are heading for possible rows over deficit-cutting. On industrial matters, the two countries often compete. The French are not happy that German trains, not French ones, will run on the soon-to-open high-speed link between Moscow and St Petersburg, nor that Siemens is pulling out of its nuclear joint venture with Areva. And the French are not blind to the need for other ties in Europe. They still hope to draw the British into a common European defence policy, even under a Conservative government. It is far harder for two countries to steer an EU of 27 members than one of 12. Yet the French expect the most from Germany—and it is not clear they will get much.

(Source: From The Economist print edition, BERLIN AND PARIS)

The pyramid principle

Oct 22nd 2009
America’s big banks are getting healthier. The small fry are not Shutterstock

JUDGED by their giant compensation bills, Wall Street’s banks are in fine fettle. But pay is one of the few numbers in their accounts it is easy to make sense of. The investment banks may be booming but they remain black boxes. Both Goldman Sachs and Morgan Stanley, which reported a third-quarter profit of $498m on Wednesday October 21st, continue to take high levels of trading risk.

The accounts of big, troubled banks—in particular Bank of America (BofA) and Citigroup—are awash with exceptional items, including tax gains and changes in the value of their own debt. After adjusting for the funny stuff, those two firms’ common shareholders still made losses in the third quarter. Transparency did at least take a small step forwards at Wells Fargo, America’s fourth-biggest bank by assets and its most taciturn. As well as unveiling a $2.6 billion profit, it announced this week (by press release) that it would start conducting conference calls for investors and stockmarket analysts from January.

Such gripes aside, there is a clear sense that things are improving. The big banks seem to think that the provisioning cycle for bad debts overall is at or near a peak. Meanwhile they are writing up the value of some of the toxic securities whose prices have bounced along with almost every other asset in the known universe. There are still minefields aplenty: the latest Moody’s/REAL commercial-property price index showed another monthly decline, of 3%, in August, and credit cards remain weak for most firms. But the optimism that has prompted bank shares to soar has a foundation. Better still, capital levels are improving as the biggest banks retain their profits, sell assets and exchange debt for common equity.

Still, as a policymaker or a taxpayer, it is hard to view the banking system with anything other than mild nausea. Most of the queasiness stems from the continued accumulation of bumper compensation packages. The Treasury’s pay tsar is thought to be considering imposing deep pay cuts on the 25 most senior executives at firms it still owns shares in, including Citigroup and BofA. But since the bigwigs probably account for under 1% of the total compensation at those banks this would be a largely symbolic move.

The chances of a more severe government response is nevertheless growing. Now the emergency is over, the full horror of a banking system that is too big to fail is becoming ever more apparent. Both Goldman’s and Morgan Stanley’s value-at-risk numbers, a statistical measure of worst-case-scenario losses, remain high. Neither bank’s balance-sheet is shrinking, although they do both have more safe assets like government bonds than a year ago.

At the remaining two big banks with state ownership, things still look very messy. Citigroup has stuck its nastiest bits, including consumer loans and toxic securities, into a separate division, but the hard part lies ahead. At $617 billion this unit’s assets are about a third of Citi’s total, and winding it down will be difficult. At BofA, too, the residual pong of empire-building is hard to ignore. It continues to book more bad debts from Countrywide, a mortgage lender it bought last year.

Yet if the investment banks and the two giant conglomerates present a big regulatory headache, as much concern should focus on those banks further down the scale. In the second quarter of this year America’s banking system overall slipped into the red as bad-debt provisions mounted. There is likely to have been more pain in the third quarter. CreditSights, a research firm, reckons 600 to 1,100 of America’s 8,200 banks may need help from, or winding down by, the Federal Deposit Insurance Corporation, compared with the 118 that have failed since the beginning of 2008.

Right now America’s banking system resembles a pyramid. At the top, two or three firms are doing well. But beneath them are a handful of giant conglomerates that are struggling towards profits, a tier of middling banks with overexposure to risky assets, and a vast base of small banks in deep, deep trouble.

(Source: The Economist print edition, Photo from different source)

Dollar depreciation

Denial or acceptance

Oct 22nd 2009

The dollar’s slide is complicating life for countries with floating exchange rates

IN ONE sense, a weak dollar is good news for the world. Behind the global economy’s current revival is a returning appetite for risky investments, such as equities and corporate bonds. At their most panicky investors shunned all but the safest and most liquid assets: American Treasuries were a favoured comfort blanket. That demand for safe assets prompted a rally in the dollar in the months after the collapse of Lehman Brothers last September.

Now that stockmarkets and economies have bounced back, dollar weakness has returned, causing a headache for countries with floating exchange rates (see chart). That has prompted three responses: direct measures to stop currencies rising; attempts to talk them down; or acceptance of a weak dollar as a fact of life.

Brazil has gone for the direct approach. Foreign capital has flooded in, attracted by the healthy prospects for economic growth and high short-term interest rates. That has pushed up local stock prices, as well as the real, Brazil’s currency. To stem the tide, the government this week reintroduced a tax on foreign purchases of equities and bonds. Though many doubt the long-term efficacy of such measures, it had an immediate effect. The real, which had risen by more than one-third since March, fell by 2% (before regaining some ground). Brazil’s main stockmarket dropped by almost 3%.

Others have resorted to talking their currencies down. In a statement released after its monetary-policy meeting on October 20th, Canada’s central bank said the strength of the Canadian dollar would more than offset all the good news on the economy in the past three months. The currency’s strength would weigh on exports, said the bank’s rate-setters, and mean that inflation would return to its 2% target a bit later than previously forecast. Foreign-exchange markets took the hint: the Canadian dollar fell by 2% against the American one after the bank’s statement.

Europe’s efforts to contain the dollar’s weakness have had rather less impact. This week the dollar slid to $1.50 to the euro, just as Henri Guaino, an adviser to Nicolas Sarkozy, the French president, described such a rate as a “disaster” for Europe’s economy. Mr Sarkozy has often moaned about the harm done to exporters by a muscular euro.

Other euro-zone countries are less rattled. “A strong euro reflects the strength of the European economy,” shrugged Walter Bos, the Dutch finance minister. Germany, Europe’s export powerhouse, feels that its firms can just about live with a euro worth $1.50. Its exporters still flourished when the euro last surged to that level, because demand from Asia and the Middle East for its specialist capital goods proved insensitive to price. France, however, struggled. A report earlier this year by the European Commission showed that French exporters lost market share in the euro’s first decade. Other euro-area countries such as Greece, Ireland, Italy and Spain have at least benefited from the recent revival of risk appetite through lower premiums on their debt.

Even so, there is palpable concern that the dollar’s decline might get out of hand. Jean-Claude Trichet, head of the European Central Bank (ECB), has repeated his line that policymakers across the Atlantic say a strong dollar is in America’s interests. That is meant to signal a shared interest in avoiding a dollar rout. In fact America needs a weak dollar to help revive its economy and reorient it towards exports and away from consumer spending. Since China and some other Asian countries track the dollar, the burden of exchange-rate adjustment falls on the euro. Mr Trichet, Joaquín Almunia, the European Union’s economics commissioner, and Jean-Claude Juncker, who chairs the Eurogroup of finance ministers, will visit China later this year to press for a stronger yuan.

Some think part of the solution is in the gift of the ECB: if it lowered its interest rates it would weaken the euro against the dollar. Yet the monetary-policy setting in the euro area has scarcely been different from that in America. The ECB’s main policy rate, at 1%, is higher than the Federal Reserve’s, but it has been so liberal with its provision of long-term cash loans to banks that excess money has pushed market interest rates close to those of other rich economies. A strong euro may even help by allowing the ECB to maintain a loose monetary stance for longer, says Stephen Jen of BlueGold Capital, a hedge fund.

The ECB will eventually face a problem that some central banks are already encountering. As long as America keeps its interest rates low, attempts by others to tighten policy (even stealthy ones that leave benchmark rates unchanged) are likely to mean a stronger currency. That is a price that Australia’s central bank seems prepared to pay. The minutes of its policy meeting on October 6th, at which it raised its main interest rate, revealed the exchange rate was not a consideration. The bank’s rate-setters ascribed the Australian dollar’s rise to the economy’s resilience and strong commodity prices. In New Zealand, similarly, the central-bank governor, Alan Bollard, told politicians that the kiwi dollar’s strength would not stand in the way of higher rates.

When the global economy was in free fall, all countries looked to stimulate their economies at the same time. “What looked like co-ordination was really coincidence,” says David Woo of Barclays Capital. Recovery is more uneven. Countries with greater exposure to buoyant emerging Asia, such as Australia, are sanguine about a weak greenback. Even Japan seems relatively unfazed. But elsewhere, an ailing dollar feels much more threatening.

From The Economist print edition, Illustration by S. Kambayashi

The Nobel prize for economics

The bigger picture

Oct 12th 2009
From Economist.com

This year’s Nobel prize has rewarded the use of economics to answer wider questions

NEITHER Oliver Williamson of the University of California at Berkeley nor Elinor Ostrom of Indiana University at Bloomington was widely tipped to win this year’s Nobel prize for economics. This may be because their work sits at the boundary of economics, law and political science, and tackles different questions to the ones that economists have traditionally studied. Ms Ostrom is also notable as the first woman to win the economics prize in its 40-year history.

Mr Williamson and Ms Ostrom work independently of each other but both have contributed plenty to economists’ understanding of which institutions—firms, markets, governments, or informal systems of social norms, for example—are best suited for conducting different types of economic transactions. Why, for example, do some transactions take place within firms, while others are carried out in competitive markets?

Ronald Coase, a British economist who won the Nobel prize in 1991, argued that in some situations, and for some kinds of transactions, administrative decision-making within a single legal entity (ie, a company) is more efficient than a straightforward market transaction. Mr Coase’s arguments were influential and convinced economists that the internal workings of organisations were worth paying attention to explicitly. But it was left to Mr Williamson to refine Mr Coase’s theory and clarify what features of certain transactions made carrying them out more efficient within a firm rather than in the market.

Mr Williamson showed that complex transactions involving investment decisions that are much more valuable within a relationship than to a third party are best done within a firm. Part of the problem, he argued, was that some economic transactions are so complicated, and involve so many things which could go wrong, that writing a legally enforceable contract that takes all possibilities into account is impossible. Simpler transactions are completed easily in markets; more complicated ones may demand firms. But in later work he also showed that organising matters within companies had costs: in particular, it relied on internal authority to get things done, and this could be abused.

Ms Ostrom has concentrated on a different aspect of economic governance. She has spent her life studying how human societies manage common resources such as forests, rivers, pastures or wildlife. Just as with public goods, it is difficult to prevent people from using the commons. But unlike public goods, and like private ones, what one person takes leaves less for others. Economic theory then predicts that rational individuals will overuse these resources.

Economists (including Mr Coase) have tended to emphasise property rights as a solution to the problem of managing common resources. Typically that involves either privatisation or putting the resource in government hands. But Ms Ostrom, who is a political scientist by training, spent much of her early career studying how communities managed such common resources. She found that groups of people tended to have complex sets of rules, norms and penalties to ensure that such resources were used sustainably. Such self-governance often worked well.

Successful informal institutions, she found, have certain features in common, which sets them apart from institutions that fail. The principles of game theory, particularly the theory of repeated interactions, proved remarkably useful in formulating general principles of how common resources ought to be managed without necessarily resorting to private or state ownership.

Mr Williamson launched an entire branch of economic theorising which looks more deeply into firms than economists had tended to do previously. His theories have also helped with understanding the choice between equity and debt, and corporate finance more generally. Ms Ostrom’s research has spawned many experiments about how people interact strategically. Some of these have influenced game theory, which originally provided Ms Ostrom with her analytical tools.

The Nobel committee’s decision, like earlier awards to Amartya Sen and Daniel Kahneman, is a welcome shot in the arm for research that crosses disciplinary boundaries in the social sciences.