Panama Canal Expansion Prepares to Open

Good news for global shipping: the Panama Canal expansion is set to open around June, the canal authority said this week. That puts the project relatively on schedule. The construction of locks, the core of the construction, might be 2 years late and 60 percent over budget, but it substantially follows the original scope and design. The construction team has started testing the new locks, the last step before opening.

With the expansion, the capacity of the canal will, for the first time, depend mainly on the weather. When ships pass through at the capacity of the locks and channels, the supply of fresh water that makes the locks operate will eventually run out, forcing a slowdown. This has historically been a possible constraint in very dry years in the Panama Canal, but now becomes a concern in all but the rainiest summers. With few options for expanding the fresh water supply to the canal, it may not be possible to expand its capacity any further than this.

This Week in Bank Failures

Stock prices are evidence enough that Wall Street is worried about banks. Major U.S. banks are trading below stated liquidation value, an indication that investors don’t quite trust the management, balance sheets, or future prospects. An unguarded comment by the Goldman Sachs CEO on CNBC, referring to current U.S. politics as “a dangerous moment,” reinforces the impression that Wall Street banks are, to put it mildly, not feeling comfortable. A who’s who of European banks have also seen their stocks tumble this year and now there is worry about the possible disruption of a United Kingdom exit from the European Union. Oil countries have mostly been able to keep their banks standing so far, but at considerable cost. Oil country banks will not recover until global oil prices double from current levels, but analysts are beginning to wonder if that will ever happen. Besides the problems of oil industry loans, a broad decline in the prices of industrial commodities may put banks’ mining and manufacturing loans at risk.

Finally, the size of the banking system in China is cause for concern. Bank assets and liabilities in China are larger than all of North and South America combined, a risky top-heavy arrangement that, absent a global economic miracle, will require state intervention this year. Banks in China face bubbles in stocks and real estate (both financed largely by bank lending), an overextended manufacturing sector, the overhang of a decade of lax regulation, a series of natural and man-made disasters, a slowing national economy, and worries about a possible global recession. Everything has to go nearly perfectly to avoid a systemic failure. China will surely have to pursue inflationary policies for several years to rescue its stock market and banks and to try to prop up its flagging factories.

Former bond giant Pimco continues to shrink at a startling but manageable rate, with its Total Return Fund showing $1.1 billion in outflows in January. Outflows make it harder for fund managers to maximize returns, as liquidity has to be given greater priority, and the fund is hurt by a lackluster performance, with a return under 1 percent in 2015.

Legal setbacks this week: Barclays, Credit Suisse, Wells Fargo, Deutsche Bank. Cutting costs: Lloyds Bank, with 1,755 retail job cuts announced.

A credit union was rescued by a NCUA-assisted merger. Montgomery County Credit Union in western Ohio was already in conservatorship and as of January 31 was merged into Bridge Credit Union. Prior to the merger, Montgomery County Credit Union had 6,000 members and $27 million in assets.

State regulators in Ohio placed another credit union into conservatorship yesterday. Cory Methodist Church Credit Union has 700 members. For now, members can conduct transactions at Steel Valley Federal Credit Union.

Today, Wisconsin state regulators ordered the liquidation of CTK Credit Union. It had 400 members, who were members of Christ the King Baptist Church of Milwaukee.

Undersea Tunnel Sought to Connect Helsinki and Tallinn

Helsinki and Tallinn, the capitals of the Baltic Sea countries of Finland and Estonia respectively, have agreed in principle to build an undersea rail tunnel connecting the two cities. The 80-kilometer rail link will be the first major rail connection between Finland and the outside world, but it is equally important for Estonia, making it practical for Tallinn residents to work in Helsinki. Already, thousands of people make the daily commute from Tallinn to Helsinki despite a 2-hour ferry ride. The reverse trip is also a popular day trip for Helsinki residents, who may see sights or visit restaurants in Tallinn, then drink beer to pass the time on the ferry ride home. The tunnel, which is hoped to be complete in 2030 at an estimated cost of €13 billion, will effectively bring the two cities closer together.

The proposed tunnel lends more weight to another rail project to connect Tallinn to Poland by way of the two countries in between, Latvia and Lithuania. This would make Finland more readily accessible from the other countries of the European Union, largely taking away the current commercial perspective that Finland is effectively an island that must be approached by sea or air. In the live music business, for example, this could result in more tours visiting Finland and more Finns traveling to music festivals across Europe.

It would be a bit of an exaggeration to say that all this is on the drawing board, however. Only preliminary studies have been done and it will take at least two years of detailed engineering studies before funding can be sought for construction. Once funded, the construction itself would take at least several years, as you would expect for a project of this scale.

I am always encouraged to see plans for high-speed rail being placed underground, as in the case of the Talinn-Helsinki tunnel. I believe the future high-speed rail network must be mostly underground for safety and efficiency reasons. A tunnel is protected from weather events, for example, and it provides the shortest route between two points.

Low Oil Prices Boost Hotels

Low prices for energy, particularly oil-based fuel, are good for the economy in general but are particularly good for the hospitality sector. Energy costs represent a significant part of the cost structure of a hotel, most notably for climate control in winter and summer, so lower energy prices reduce the cost of operating a hotel. At the same time, low prices for fuel make people more willing to travel, particularly by car and airplane, and that results in more customers at the hotel. E-forecasting.com in its latest monthly HIL index is projecting a boost of 0.2 percent in the hotel business, largely on the basis of the decline in energy prices in December. This follows a series of upward moves in the HIL previous months. E-forecasting.com says the HIL is a leading indicator that is four to five months ahead of changes in business results at U.S. hotels.

Answers in Chipotle Report

The earnings report from U.S. restaurant chain Chipotle Mexican Grill hints at answers to two of the questions customers have been asking. The more important question of the two is why Chipotle can’t change its slapdash food preparation approach. Chipotle’s financial results point at the answer to this. Revenue at Chipotle was down 15 percent as customers stayed away following three highly publicized disease outbreaks originating in the restaurant chain. Profit, though, was down 45 percent. When a business’s profit falls faster than its revenue, this points to the fixed costs of the business. These are the costs the business must bear regardless of the number of customers. If profit falls three times as fast as revenue, this is a business that has an unusually high proportion of fixed costs for the restaurant sector. To make a profit at all, Chipotle must bring in as many customers as it can, regardless of its ability to handle the workload. To put it another way, Chipotle has to force its customers to wait in long lines and push its food-assembly workers to work an unnaturally fast pace to make a profit at all.

The unfortunate other side of this effect is that Chipotle will fail spectacularly when consumer tastes change, something that inevitably happens within a matter of years in the fickle restaurant business, all the more so in restaurants like Chipotle where the novelty factor is intrinsic to their appeal. A decline in traffic of one third would not be a drastic change from the customer’s point of view — you would be waiting in a shorter line, but still waiting in line — but it would have the restaurant chain operating at a loss. Any adjustments Chipotle might make at that point to return to profitability, such as raising prices, closing stores, or reducing the quality of the product, would further erode revenue in what would likely be a downward spiral. Chipotle’s suggestion that heavy spending on food safety will wipe out its profits in the current quarter suggests that this downward spiral may have already begun.

The other big question was whether any of the official investigations into Chipotle’s operations have turned up anything. A criminal investigation in California may have turned up something about actions in other states, because we now know that a California criminal investigation of a single location in Simi Valley has turned into a federal investigation by the Department of Justice. Chipotle says it received the first subpoena in the federal investigation last week. The documents sought by the subpoena hint that investigators suspect a company policy directed toward covering up problems with food quality.

Chipotle ultimately probably cannot fix its quality problems because slowing down food assembly enough to fully control the process would mean giving up the high volume that it requires to turn a profit. I believe Chipotle can fix all its other quality problems, but it is easy to see why management turns a blind eye to the actual problem that it faces. There may not be a solution that allows the company to stay in business.