"The three greatest inventions of mankind are writing, money, and the Tableau Economique that binds them all together." Adam Smith

# Round 1:  The Law of Averages

I’ve never been a fan of averages.  Averages hide too much.  If you measure using averages, everything gets compressed into a neat little package.  That can be great sometimes, but without a second metric to measure, say variation, you really can lose a lot.  For example, you can compress a symphony into a single note, but what does it really tell you?

If you insist on measuring using room rate averages, give yourself some better information definition unsung average room rate per category.  Breaking up your average in this way gives you a wealth of information that a simple average does not.  Specifically, it tells you what kind of rates you are getting in each category, and how well you are really doing in terms of getting your rates right.

Why is this important?  Well if your average room rate is 333€, is it because you sold three deluxe rooms at 333€ each, or one suite for a thousand?  Did your rate come from good revenue management practices or from selling many rooms too cheaply and one overpriced suite suite as a wedding gift?  And if the latter is the case, can you really count on it happening again next week?  Or tomorrow?  Breaking down global averages into their component parts multiplies your analytical insight a hundred fold.

## The Math:

Average room rate: 453€

A pretty good average room rate.  No need to worry.

The breakdown: (Classic @ 170€ + Classic @ 190€ + Suite @ 1000€) / 3 = 453€

Average room rate per category – Classic: 180€, Suite: 1000€

A nice rate for your suite, but is is sustainable?  And is 180€ is quite low for a luxury classic room.  Could you have charged more and still made the sale?

The breakdown:  (Classic @ 170€ + Classic @ 190€) / 2 = 180€

Suite @ 1000€ / 1 = 1000€

With an average room rate per category, you get higher quality, actionable information.

Another problem with average room rate comes down to its formal mathematical definition: The total of the observations (i.e. Total Sales), divided by the number of observations (total rooms sold).  Practically, you take your total sales, lets say for the month, and divide it by the number of rooms sold that month.  Made a million euros in July and sold 4000 room-nights?  Congratulations, you made 250€ per room.  Make half a million euros and sell 2000 room-nights?  Guess what, you also made 250€ per night.  Did you only manage to sell a single room the whole month?  You guessed it, you made 250€ per night.  Average room rate, even if you break it down by room category, does not include your occupancy figures, which means that you are missing some important information.  And while its true that you can use the two numbers together, it makes direct comparison more difficult and less acurate.

## It’s easy, but so is RevPAR

In fact, possibly the only good parts about a global average room rate is that it is simple and you have been using it for years.  But the alternatives are just about as simple, and with just a bit of work, will provide you with tremendously more insight into your operation.

Next Time: Round Two: Revving it Up

### Do we really need to mutualize European debt? Or can we just mutualize the interest payments.

I read a very interesting article* recently on how to solve the European debt crisis, specifically that Europeans don’t have to mutualize or guarantee the debt of it weaker member states, only promise to pay the interest charges.

The main problem of the Euro crisis is that bond markets are worried that Spain, Italy, Portugal and now Cyprus is that they won’t be able to pay back their loans because their loan payments are too big. Recent EU focus has been on the idea of mutualizing some or all of the debt load of European countries. But Germany, not surprisingly, doesn’t want to give up access to its balance sheet without a lot of conditions, and a greater move to a European Federal Republic, something that most states are loath to do. So the ball keeps bouncing around without anything being done.

But maybe Germany and France don’t actually have to guarantee the entirety of the outstanding loans. Maybe all they have to do is help out by paying the difference between the weaker members actual interest payments, and a hypothetical EU average. After all, if things were more or less okay before all of this started, then maybe this is all we need to go back to that state of affairs. After all, except for Greece, the other euro nations are solvent. This plan is just a way to help “top up” the weaker members.

Here’s how it would work. You take the entire outstanding value of European debt and you divide it into the total outstanding payments for all euro countries the year. This will give you the average interest payment for all European debt. Then each country pays into a fund the difference between their national debt servicing costs and the average in the case of France and Germany, or takes out the difference between the average and what they have to pay. This ensures creditors that bonds will be able to be repaid without requiring the billions of dollars necessary to ensure the principle.

Here’s why I like it. From the point of view of Gernamy, they are no longer on the hook for the totality of Greek, Spanish and now Cypriot debt, only the difference between the European aveage and the national rate. That is a huge savings. Equally as important is that Germany maintains its political leverage over the deficit spenders. They have the ability to guarantee interest payments six months or a year out in the future, which insures long term fiscal discipline on the part of national governements. Furthermore, the fact that there is still default risk keeps their interest rates somewhat high, increasing the cost of capital, preventing the kind of runaway deficit spending that got them into this mess in the first place, and Germany can still keep a watchful eye over the purse strings of the nation.

There are tremendous benefits to the EU as well. This plan effectively stauches the crisis, because bond markets will finaly be satisfied that these deficit heavy countries will be able to make good on the promise to pay back their loans. That is all the market is looking for, a guarantee that bond holders will get their principal back, with interest, And of course, national coverments can move from crisis management back to actually governing their countries. But it is the more existential issues that are really worth mentioning. The European project is still underway, like a great wave halfway through its crest. They just aren’t ready for a European Federal Republic. One day they might be, but today they’re not. Sovereignty, especially in Europe, has been a hard fought and highly treasured prize. It will not be given up quickly, nor should it. Interest mutualization is a way of taking the next steps of European integrataion one at a time, not all at once.

On the Other Hand

Economics, especially macroeconomics, is not really a science in the way that Chemistry or Physics is. It helps give you some explanatory and predictive power, but any time humans are involved in something, you introduce a certain amount of unpredictability into any equation. It is in this spirit that we approach this week’s On the Other Hand

Just because I think this plan is a good idea in no way does guarantee that 1. it is a good idea, 2. European bond traders will think it’s a good idea, and 3. that it will work out in the way that I have suggested. And even if it works out beautifully, we still have riots, double digit unemployment and a socialist President in France. But at least we will have one less thing to worry about.

*I lost my browser history, and for the life of me I have not been able to find the article again. When I do, I will put in the appropriate citation.

### The End of Austerity? I hope not!

Is the end of austerity over? Is now the time for growth? These are the questions that have been circulating around Europe for the past two weeks, since François Hollande’s electorial triumph over Nicolas Sarkozy on May 6. Despite being armed with a less than rigorous electoral mandate, Hollande and his friends in the executive branch are ready to remake not just France, but Europe as a whole.

Despite the fact that for the past year capital markets have decried the Merkozy approach at ending the European financial crisis, I have remained stronly in favour of the need for austerity. Despite that Hollande’s recent comment that “the enemy is Finance”, the roots of the financial crisis, at least in Greece, Portugal and Spain, is a failure of government. Taking advantage of interest rates much lower than they would have otherwise been entitled to, thanks to the strength of the French and German economies, these countries spent money like there was no tomorrow.

Except there is a tomorrow. And with rising interest rates on goverment debt threatening to topple national governments, and citizens violently unhappy with the state of affairs, the last thing governments want to do is tighten their belts, cut spending and suffer through a recession for 18 or 24 months while the economy rebalances.

Because regardless of whether you are on the right or the left, everyone more or less seems to recognize the fact that the GDP of an economy, on the demand side at least, is the sum of consumer spending, plus investments, plus government spending, plus net exports (the old GDP=C+I+G+Net EX). There might be a lot of argument as to who does the spending, but spending is key. But if you suddenly cut out a lot of spending, your GDP is going to drop. As indeed it has. Greece’s latest estimate is that it will end 2012 with -7.1% growth (*The Economist economic and financial indicators, May 19, 2012) and the Eurozone as a whole is suffering under an economic malaise.

Now I am not trying to make the case that the cut in government spending is the only cause for our economic situation. But I am saying that it is an important component of the decline. But more importantly, I believe that despite the fact that the cut in government spending is hurting the economy, I believe it has to continue. Here’s my reasoning:

What we have tended to see over the past two years is that any time pressure has been lifted even the slightest bit, governments have tried to push off the need for spending cuts. It is a difficult and messy process, there is little real political will to do it, and if you have an entrenched interest you want to keep things the way they are.

But more importantly is the idea that it takes time to squeeze problems out of an economy. Individuals, companies, and in this case governments, have to truly believe that a new policy has been enacted before they will be willing to make bets on the new system. Usually to prove their seriousness central bankers (and in this case our German backers) have to be willing to suffer a recession to prove that they are serious. That seems to me to be where we are now.

The problem with Hollande’s new age of growth, echoed recently by Barack Obama at Camp David, is that now is exactly the wrong time to do it. If we loosen the pipes and allow credit to flow before things have changed it will simply prove that the ECB and the Germans are not really serious about wanting to change. We will have paid the cost, but not received any of the benefit. The past two years will have all been for naught.

It might sound cruel to some, but I really believe that we need to stay the course in Europe. Truly, I would not like to be in Greece right now, and I am grateful that I married a French girl and not a Greek one*. It is difficult to wean yourself off the government pipeline, but it can be done. And Greece will be much stronger for the effort. And if individual Greeks really want to improve their lot, instead of rioting they should learn German. Or Polish.

On The Other Hand

Alchemy isn’t a science. Neither is economics. Without the ability to do real, repeated and double-binded experiments, it is difficult to know if cause and effect relationships truly causal, so we don’t ever really know if we are right. In that spirit, here is this post’s “On The Other Hand”:

Germany was deeply affected by the hyperinflation of the 1930s, and there remains a deep fundamental fear of inflation. The best way to combat inflation is to make your stand and hold out until the inflation has been squeezed out, as did the Japanese in the 1970S and the Americans in the 1980s. It is possible that this is the model that the Germans have in mind, and it is definately possible that it is the wrong model to use. Maybe the best thing to do now really is to print more money, spend spend spend, and let inflation pay for everything. It’s possible. Personally though, I doubt it.

*What I mean to say, Baby, is that I am happy you are French and not Greek. You are the only one I would have ever married,and I would have married you regardless of your nationality.